Let's say you've built a nice portfolio of carefully chosen mutual funds, set up a good procedure for investing more money in them each month and dedicated a file cabinet to the records you'll need for tax returns decades from now.
What's next? At this stage, many investors are left with a kind of empty feeling. Isn't there more to your investing life than this monotonous process so many financial advisers recommend?
Thinking there must be, legions of investors are moving beyond the everyman world of funds to the Lone Ranger frontier of individual stocks. The discount brokerages and online trading and information systems that serve these folks are booming. Are you ready to graduate to stocks? Should you?
On paper, it's easy to make a case for owning individual stocks. Every day, there are stocks that go up 20 percent, 50 percent, even 100 percent. And there are lots of cases of big, well-known companies that beat the average mutual fund. Microsoft is up 77 percent over the past 12 months, and Dell Computer is up 138 percent. That's a lot better than the typical S&P; 500 index fund, which is up about 21 percent, or the average stock fund, which is up less than 5 percent. Of course, a lot of individual stocks are in the toilet.
Owning individual stocks for the long term can relieve you of the drip, drip, drip of annual expenses, fees and taxes that erode fund performance; with stocks, the only significant costs come when you buy and sell.
With a stock, you know exactly what you own; a fund's holdings are only reported every six months. With stocks, you decide what to buy and sell, and when; with a fund, that's up to a stranger whose interests, goals and motives may be different from yours.
Of course, in the real world there is no Lake Woebegone, where every child is above average. It's a mathematical impossibility for the average investor in individual stocks to beat the market's average performance. This fact lies behind the popularity of index funds, which seek to match the market's performance.
On the other hand, if we used index-fund logic in all aspects of our lives, no one would ever try to be an Olympic champion, since the average person cannot achieve this goal.
If you want to try to do that with stock-picking, what issues should you consider?
What are your investment goals? Your core portfolio of funds should be designed to achieve your goals. Individual stock investing, especially for a beginner, should be done with money you can afford to lose.
What are your financial and psychological motives? Do you want to have more precise control of your investments? Are you trying to beat the averages? If arrogance or a love of thrills drives your desire to own individual stocks, you might as well blow your money in Atlantic City.
How will you control costs? A good broker may guide you to better stocks than you'd find on your own. But if you use a full-service broker for stock picks, you may pay commissions 10 to 20 times higher than if you use an online discounter that makes no recommendations.
Can you diversify enough? Your fund holdings may provide enough diversification already. But if you plan to commit serous amounts to stocks, you need at least eight or 10 to spread out the risk. Chopping your investment budget into many pieces means spending more on commissions.
How much time can you commit? It's more work to choose individual stocks and to monitor them than it is with funds.Are you willing to spend six to 10 hours a week on this?
Where will you get information? A lot of accurate and useful information is free on the Internet, including corporate filings with the Securities and Exchange Commission, stock-price histories and news about individual stocks. But serious stock investors also use newspapers, magazines, newsletters and more sophisticated fee-based Internet sources. Those costs eat into investment returns.
If you're willing to do the work, stocks have lots of appeal -- but start small.
Pub Date: 3/14/99