- The pandemic ushered in a new class of retail investors, and many of them are interested in individual stocks.
- When family members recently texted me asking whether they should buy a stock, I asked them if they had considered index funds yet.
- I also told them not to invest money they aren't willing to lose, and said it's important to think about their overall strategy.
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I've been covering personal finance for more than four years, but it wasn't until I officially became a certified financial planner in October that my family started asking for investment advice.
Two relatives in as many weeks texted me asking about specific stocks and whether they'd be a good investment. I'm flattered that they'd ask for my advice (especially since I'm younger than they are), but investing can be a tricky topic.
To tell anyone that they should or shouldn't buy a stock without knowing what the rest of their financial situation looks like is risky. I'm inclined to ask whether they have an emergency fund or any outstanding high-interest debt, since those are a good indicator of whether someone is ready to invest in general.
Here's an extended version of what I told those family members who texted me, and what I'd tell anyone asking whether they should invest in an individual stock.
Don't invest money you're not willing to lose
This is rule No. 1 when it comes to investing, in my book. If you can't afford to lose your investment, it's probably not the time to buy the stock.
The average stock-market return over the past decade is about 9%, before taxes. But stocks go up and down all day long, and an individual company's trajectory can be a lot more volatile than an entire index or industry.
The shorter your time horizon — or the amount of time you're planning to stay invested — the riskier it becomes. The longer your time horizon, the more time you have to ride the ups and downs and wind up with an average return.
Chances are you won't lose every penny you invest in a stock — especially if it's a highly valuable company — but operating under the assumption that you can is good practice.
Consider index funds
Most people invest in the stock market to make money. It's risky, but the prospect of turning your cash into more cash is irresistible for some. Thankfully there are easy ways to reduce your risk, especially if you have many years, or even decades, to grow your investments.
Index funds are a type of low-cost, mutual fund that diversifies your money across a broad selection of stocks or bonds. Rather than choosing and buying individual stocks, an investor owns a small piece of every company or asset in the fund, which tracks an index, like the S&P 500 (the 500 largest public companies).
I recently hosted a live event where financial advisor Kevin Matthews shared one of the best analogies I've heard on this topic. To paraphrase, he said investing in one stock is like buying a single basketball team. Investing in a mutual fund is like owning the entire league; you don't have to worry about whether a player gets injured or a team performs badly, because your losses are spread out. Someone is always going to win.
That means the pressure is off you to pick the best stock, or at least one that won't lose, he said, and there's some safety in that.
Think about your strategy
If you're sure you want to buy an individual company's stock, understand why you're doing it. Are you trying to make a quick return? Are you following a hot stock tip? Do you actually use the company's products or services and believe in its mission? Are you building a diversified portfolio?
Your reason for investing in the first place is really what should determine what type of investment you choose, whether an individual stock, a mutual fund, or something else.
There's nothing wrong with buying individual stocks. Plenty of investors do and manage to be quite successful over the long term, particularly those who use a buy-and-hold strategy.
But for the vast majority of investors, buying and trading individual stocks successfully takes a huge amount of time, skill, and restraint. Even as a financial planner, I'm not in the business of timing the market.
Sallie Krawcheck, a former Wall Street executive and now CEO of Ellevest, put it bluntly at the start of the pandemic: "For an individual investor to think they somehow know something that the market doesn't know and to be able to trade around it and make money is an absolute fool's errand."
Tanza Loudenback, CFP®, is the personal-finance correspondent at Business Insider. She writes most frequently about saving money, planning for retirement, taxes, debt management, and strategies for building wealth. Have a money question for Tanza? Fill out this anonymous form.
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