“BUY WHAT YOU KNOW.” It’s super-cliché investing advice, but it’s an adage I took to heart when making my first stock pick.
As a long-term index fund investor myself, this book is part of the reason I decided I should at least try out individual stock picking. (We’re not talking day-trader-level stuff.) Instead of going for some of the low-hanging fruit of things I knew, like buying some shares of Netflix or Amazon, I went with an oddball choice.
My dad works in the lithium industry. As a seven-year-old, I could parrot fun facts about lithium being the lightest metal on the periodic table of elements and that it’s used in batteries and depression medication. I probably freaked out some grown-ups with that one, but come on, Nirvana had an entire song about lithium!
Anyway, lithium has been on something of a hot streak in the last decade, as evidenced by the rise of companies like Tesla and the interest in green energy. I even had an interesting experience doing PR for a company that built battery-storage facilities for storing renewable energy. Suffice it to say, for not working in the lithium industry, I had some familiarity with the product.
So, when deciding which stock to buy, I went with a lithium-related option. And let me tell you, it’s been quite the volatile ride.
I invested about $5,000 in the stock. Five grand is certainly not chump change, but it was also an amount of money I could stomach losing if everything went sideways. In three months, it had doubled in value. By six months, my $5,000 investment had risen to over $14,000. Man, was my first stock-picking rodeo going better than I could’ve imagined. Then it stopped its upward trajectory and began to backslide. The investment dropped from $14,000 to $7,000 in four months, but I was still up by over $2,000. Even though that’s still a nice chunk of change, it was painful to look at the graph and see how much it had fallen since its peak.
However, this stock choice was a buy-and-hold strategy for me, just like much of my index fund investing. So, what will ultimately happen remains to be seen.
It’s been mentioned a few times already in this book that individual stock picking should not be your primary means of investing. In fact, for many, it shouldn’t even be a contender. However, I’m not about to write an investing book for beginners without addressing it. So, here it is. I will give you information about how to pick individual stocks, but that by no means should indicate that I think it’s a wise financial move for the average rookie investor. Most seasoned investors don’t get down with day trading, and many don’t even dabble in individual stocks.
“I did day trading before, and it drove me insane,” says Ashley Fox, a financial education specialist. “I’m too busy to day-trade, so I’m a long-term investor. My favorite holding period is forever.”
But you may be convinced that, at some point, you’ll want to purchase some individual stocks. (I mean, I did, so who am I to chastise the choice?) Here’s what you should know.
We’ve been discussing diversification, risk tolerance, asset allocation, and goal setting ad nauseam throughout this book by this point. And you’ll just keep hearing about them, too, because they are critical parts of building an investing portfolio that will weather the ups and downs of the stock market. They are how you sustainably build wealth. Individual stock picking is deliberately not mentioned as one of the best ways for the average investor to build wealth because when you consider individual stock picking, you need to be prepared for one thing: could you withstand losing it all?
“[Stock picking] is an entire job,” says Colleen Jaconetti, CFP®, senior investment analyst for Vanguard Investment Strategy Group. “You have to know: Is it a strong company? What’s going on in the industry? What’s going on that could impact the product that people are putting out? How is the company managed? Unless you really have the time to do the analysis on the company and the industry, to know all the factors that impact that company, it’s very difficult to pick one company or another.”
Even though Jaconetti doesn’t recommend focusing on individual stock picking as a significant part of your portfolio, she certainly understands the appeal: “When my husband and I got married, he was in IT and wanted to invest in Cisco. So, we took a small amount of money and invested in Cisco because that was important to him. But, for the most part, that’s not part of our long-term investment portfolio. That is truly his ‘I’m passionate about this company, I love it, I’ve been reading about it for three years, and I really want to do this.’ Okay. But I certainly wouldn’t let him do that with our financial future.”
Even those who make stock picking their full-time jobs don’t always outperform the market index. In fact, they often don’t. A cat has been shown to be a better stock picker. Okay, so it didn’t use the scientific method—but a goofy contest run by the Observer back in 2012 pitted a cat named Orlando against a panel of professional traders1 (specifically, a wealth manager, a stock broker, and a fund manager) and students from a secondary school. Three teams (two human; the third, the feline) started out with £5,000 each to invest in five stocks from the FTSE All-Share Index. The humans picked stocks based on experience, knowledge, and, supposedly, skill, while the cat threw a toy mouse at a grid of numbers that corresponded to potential stock choices. Each quarter, all the teams could exchange any stocks from the index. By the end of the fourth quarter, Orlando increased his portfolio 4.2 percent, to £5,542.60, compared to the team of trained professionals’ £5,176.60.
“People need to have the right attitude for investing,” says Dave Nugent, head of investments for Wealthsimple, “and not treat the stock market like the lottery or Vegas. They need to realize when they’re investing in the stock market, they’re actually investing in real companies that sell real products and provide real service to people. I think it’s easy to get caught up in the fast pace of the market.”
The stock market so often gets compared to gambling because neither one promises guaranteed returns. It’s not an apt comparison, though, even for individual stock picking, and it’s one that’s likely to make investors bristle a bit.
For one thing, being an investor means you own a piece of the company—no matter how small. Putting a $100 bet down at the blackjack table at the Venetian doesn’t mean you’ve purchased $100 worth of ownership in the Venetian.
Both require levels of risk analysis, but what happens when you win big in Vegas? You should cash out. Quit while you’re ahead. The house is supposed to always win, and the game is rigged against you. If you keep playing, then you’re going to lose your money.
Investing is pretty much the opposite. You’re supposed to take the long view and ride the ups and downs. On average, the market yields healthy returns for those who stay in. Granted, that advice is typically for a well-diversified portfolio and not exclusively for individual stock picking, but it can be true for individual stocks if you’re taking well-researched positions and have a buy-and-hold strategy as opposed to day trading.
Perhaps a big windfall from investing produces a similar euphoric high as one you’d get on the floor of a casino, but investing and gambling are not synonymous.
“If you think about investing in individual securities, it’s risky because you are investing in the success of one company or a handful of companies,” explains Maria Bruno, CFP®, a senior investment analyst for Vanguard Investment Strategy Group. “And what’s happening then, potentially, is that you are pivoting away from the general broad market. So, when you see the market movements, your individual portfolio might perform quite differently because you’re invested in one or two or a handful of securities. So just be really careful in terms of how much you own in individual securities.”
Plenty of experts will caution you against buying individual stocks, but Avi Lele, founder and CEO of Stockpile, sees individual stocks as a way to get people in the investing game. Stockpile, an online investing service, is a way for investors to buy, sell, and even gift fractional shares of stocks.
For example, Sam wants to buy stock in Bamzon, except Bamzon is currently trading at $1,400 for a single share. He doesn’t have that kind of money, but he could purchase $100 worth of Bamzon, which would mean he’d own around 7 percent of a share. If Bamzon started to pay dividends to its investors, then Sam would receive 7 percent of a dividend.
Buying fractional shares isn’t particularly common because the stock market doesn’t trade in fractions. What Stockpile does as a brokerage is it buys the entire share and then holds the leftover fraction. When Sam placed his order for 7 percent of Bamzon, Stockpile purchased the entire share at $1,400. On the same day, Mary placed an order for 40 percent of Bamzon, Jake bought 30 percent, and Tony purchased 5 percent. After all those purchases, Stockpile held the remaining 18 percent of the share.
The value of individual stocks has a few angles, explains Avi Lele. “The first thing we find is that it’s the thing that gets you to get started. It’s hard to get excited about a nameless, faceless ETF or mutual fund. Whereas everyone has brand affinity, so the thing we find is that people come in through brand affinity. They basically say, ‘I didn’t know I could own Facebook stock. I know a lot about that company, or I’m a big user of Nike products, so let me buy some Nike stock.’ That’s the thing that makes the on-ramp really easy for people. They’ve got at least one thing they understand, which is the actual company that they’re investing in.
“But that doesn’t mean that now they should embark on a path of only buying individual stocks. It often makes a lot of sense to branch out into ETFs. If you can take an ETF and kind of bring out what specifically the ETF does, like supporting the troops or clean-and-green, then you can teach people along the way this is what’s in the ETF. This particular ETF has stocks that translate into defense contractors and other military-type companies, while this other ETF is solar and wind and companies like that. The same thing that tends to work for stocks also works really well for ETFs.
“Some people start off saying, ‘I just want to buy an S&P 500 ETF and just get that bedrock foundational investment in place, and then I can add to it with other things that I feel like would be good investments.’ Whereas other people on the other end of the spectrum start off with an individual stock and keep diversifying their individual stock portfolio. It’s another equally valid way to diversify. Either way, all the rules apply. Start early, diversify, do it regularly, and do it for the long haul.”
So, you’ve decided it’s time to add some individual stocks to your portfolio. It could be because you see real value in a particular company or that you’re curious about the experience. Either way, here are some questions you should be able to answer when deciding which stock to pick.
“Don’t put all your eggs in one basket,” says Vanguard’s Maria Bruno, CFP®. “It’s very natural for individuals to have the desire to hold some individual securities. While that may be fine, don’t let it be a large part of the portfolio. I sometimes say, ‘Have a little bucket of play money.’ And don’t let that impact your overall portfolio.”
Before you make a decision about which company stock you want to buy based on knowing, using, and understanding the product—you should probably check its share price. There are plenty of companies with shares that cost hundreds or upward of a thousand dollars.
You still need to be diversifying. Even if you decide to go all-in on buying individual stocks and not to include a mutual fund or ETF in your portfolio (100 percent advising that this not be your strategy), then you shouldn’t go all-in on one particular stock or even one sector.
Avi Lele understands the pressure of having all your money in one stock: “I finally had enough money and enough courage to go in and hope I didn’t screw it up. I bought fifty shares of Microsoft, and then I was just a little overextended. I was in one stock, and it was at least a company I understood. I remember the share price, it was like $98, so I was in with just under $5,000. I was sitting there sweating it out every day, thinking, ‘I hope it doesn’t go down.’”
Had he been more diversified, it could’ve helped reduce his panic.
This shouldn’t be a “trust your gut” decision. You need to back up your feelings with at least a rudimentary analysis of the company.
Is it profitable?
A company’s corporate report can give you details on its finances. Companies often have to file this information with the SEC, so you may be able to find it on the company’s website or at SEC.gov.
Is it reputable?
You may not know what’s happening inside the company, but whistle-blowing has become increasingly common in recent years. Just searching the news usually lets you know about prior or current scandals.
What’s the history of returns?
Go to Morningstar and look up the stock you want to buy and check its chart to see the company’s growth.
It’s not imperative that you understand all the inner workings of the company, but you should at least be able to explain what it does. This strategy can prevent you from chasing the latest hot tip and ensure you’re investing in something you understand. Bitcoin is a great example of people dumping money into a commodity they may not have understood just because everyone else was doing it. Those who understood blockchain could make well-researched, calculated investments. Those that didn’t were simply throwing money into an investment.
It’s easy to get caught up in the frenzy of a hot commodity. Try to avoid buying in when your friends, family, dentist, and the random person you started chatting with on the street all recommend one particular stock, because that means the price is going up! You don’t want to buy when the share price is high.
The first time I opened up a brokerage account with the intention of buying a specific stock, I had to spend about thirty minutes looking up definitions before I could take a half-assed, semi-educated guess at how to place the order. I remember looking at all the options and thinking, “I don’t know! I just want to buy $5,000 worth of this stock! HOW HARD IS THAT TO DO?!”
Here are the things you may need to know before you log in to buy stock through your brokerage:
The name/symbol of the stock
Okay, this one is fairly obvious and simple to find.
The action you want to take
You’ll probably have the option to buy, sell, or short-sell. In this case, you want to buy.
How many shares you want to purchase
The platform you pick will likely offer a calculator to help you figure out how many shares. You plug in the amount you want to spend, and it’ll tell you how many shares that equals at the current market price. If there’s no calculator, then it’s pretty easy for you to figure out yourself. Let’s say the stock you want to purchase costs $5 per share and you have $100 to invest. You’ll want to buy twenty shares.
The order type
Market order: You want to buy the stock, period. You’re willing to do this at the best price available, which is whatever the market is currently dictating. By placing a market order you guarantee that you’ll make the purchase, but you won’t be guaranteeing the price.
Limit order: A limit order does the reverse of a market order. You guarantee a price maximum that you’re willing to pay, but there’s not a guarantee the order will successfully get placed. Limit orders can be used as a buyer and as a seller. Limit orders can also mitigate the risk of paying a higher price than expected, which can happen with a market order.
Stop-loss order: There is a buy stop-loss order and a sell stop-loss order. With a buy stop-loss order you place an order above the prevailing market price on the stock. If the stock hits your price, then the order you placed will become a market order and get placed at the next available price. With a stop-loss order, you can decide how much you’re comfortable with a stock drop before you’re willing to sell. This can remove some of your emotional attachment to an investment. Let’s say you bought ten shares of Mosbius Designs at $30 per share, but if the stock falls more than 15 percent, you want to sell it off because you aren’t willing to risk more than a 15 percent loss on it. You then set a stop-loss order for $25.50. If Mosbius Designs hits $25.50, then your broker will sell the ten shares for you. Once your stop-loss order is reached, then it converts into a market order and will be sold at the next available price. This could cause a problem as you could end up buying or selling at a different price than you wanted.
Stop-limit order: The stop-limit order combines the limit order with the stop-loss order. This means you set your stop price, or the price at which you want to buy or sell the stock, but you also set a limit price. You were willing to buy Mosbius Designs at $30, but if it hits $35, you no longer want to place the order. Similar to the limit order, you are not guaranteed that this transaction will execute.
Timing
Day only: Your request to purchase will expire at the end of the trading day if it’s not filled. (This is usually the default.)
Good until cancelled: Your request will live on for usually thirty to ninety days, or until it’s been fulfilled or cancelled.
Fill or kill: The request to purchase is either immediately fulfilled in its entirety or cancelled. For example, you want to buy 200 shares of Mosbius Designs at $15 per share. Your broker isn’t able to fulfill this order for you, so it gets cancelled.
Immediate or cancel: You want the trade immediately filled, either entirely or partially. Whatever isn’t filled is cancelled. You still want 200 shares of Mosbius Designs at $15 per share, but your broker is only able to get 120 shares for $15 per share. She buys those for you and cancels the remainder of the order.
What you want to do with your dividends
The platform I use requires you to opt in by checking a box next to “reinvest dividends,” which would be easy to overlook. Some investments may not allow you to reinvest your dividends.
Whether there are commissions and/or trading fees
Be sure to calculate that into the total cost of your purchase.
How your transaction is being funded
You might have a cash reserve set up with your brokerage—fine. But if money is getting pulled out of your bank account to fund the purchase, then it could take a few business days to complete the order. That can make a world of difference when it comes to share prices.
Tela Holcomb, an independent trader and the founder of the investing program Trade Your 9 to 5, started her stock-picking journey in the virtual world.
“I started in a practice account,” says Holcomb. “That’s a huge tool for beginners who don’t know what they’re doing in the beginning and are scared and don’t want to lose money trying to learn.”
Practice accounts may not be quite as prevalent as they used to be, but you can still find some online where you even compete against other people with virtual cash. Investopedia offers its Stock Market Game and TD Ameritrade offers paperMoney® for dabbling in virtual cash. Just make sure you read all the terms and conditions before you sign up, to ensure you’re not going to start getting charged.
Outside of an employer-sponsored retirement plan, you may also have the benefit of purchasing company stock. Oftentimes you’re able to get access to this stock at a lower-than-market-value price, which makes it a deal. Still, company stock should be only a small part of your overall portfolio.
“Avoid concentrated investments,” says Jaconetti, noting overinvesting in company stock as an example. “When you buy company stock, your financial future with your salary is highly tied to that company already. You double down almost by then buying a lot of company stock. It’s just putting that much more of your future in that company’s hands.”
It’s not terribly complicated to find where to buy stocks. You can go through most major brokerage firms and just place the order online. You don’t have to call up an individual stock broker you hire in order to place the buy. You should compare commissions and fees, though, if you’re trying to decide which brokerage firm to use. Options to consider include: Ally Invest, Charles Schwab, E*Trade, Fidelity, Merrill Edge, and TD Ameritrade.
While robo-advisors do use ETFs to build portfolios, not many of them provide an option for purchasing individual stocks. Robinhood is one app that does.
☐ Are you okay losing all the money you’re about to invest in an individual stock?
☐ Do your research and thoroughly vet the company before making the purchase.
☐ Pick a brokerage firm.
☐ Decide how much you’re going to invest and how you’re going to place the order.
☐ Determine ahead of time if this is a buy-and-hold purchase and then remind yourself of your goal in order to emotionally handle volatility.