I recently sold off all my shares of another company that I invested in, leaving me with only one stock investment left (that I’m likely to sell soon, too). This stock I just sold performed poorly (I lost money) since a bought it a couple years ago, but that’s not even my principal reason for selling. In fact, I’m not jaded by my stock investing experience at all. I’ve had good luck (yes, I really do feel my other pick came down to luck, not skill), as my remaining stock investment has returned about 250% in the two years I’ve owned it.
My reason for selling is that stocks are not the best choice for the casual investor. I would consider anyone that’s not some sort of investing professional a “casual investor”. In fact, many of those that consider themselves seasoned investors should be looking to options other than stocks, too.
Why No Stocks?
First off, the idea of picking individual stocks turns people off to the idea of investing in the first place. People think all investing is complicated and only for the elite. Others think they need insider knowledge or to read magazines and other sources constantly to keep up with the changing markets. They also believe that you need to constantly manage a portfolio, making trades on a weekly or monthly basis. This simply isn’t the case.
Secondly, anyone that thinks they are going to consistently beat the market picking stocks is foolish. As Ramit points out in I Will Teach You To Be Rich, Warren Buffet, among the best of the best on investors, has returned about 22 percent annually on his investments for forty years. 22 percent is fairly modest to you and me, especially if you’re only investing a few thousand dollars each year. And, let’s not forget: You’re not Warren Buffet! Even greatest investors out there can’t expect a return that’s a hell of a lot higher than the market itself returns (which is about 10% per year, historically).
The Easy Alternative to Stocks
What’s the solution without stocks? Investing in mutual and index funds.
I personally like index funds because they have a much lower expense ratio than mutual funds typically do. Owning a mutual fund will typically cost 1.5-3% of your investment each year, while index funds often cost around 0.25% (my Fidelity Total Market Index Fund is 0.10%). This is because index funds are essentially run by a computer whereas mutual funds are run by a person (and that person wants to be paid!) While mutual founds may not sound expensive, that 1.5-3% eats into your earnings and can have large affects over long compounding periods. Besides expense ratios, many index funds outperform mutual funds anyway. Easy choice, right?
The returns you can expect on index funds are essentially the same as how the market performs: about 10%, annually . I know that no one’s stock market fantasy involves an 10% return, but expecting more than that is incredibly unrealistic when considering what the pros return on their investments.
If You Still Want to Buy Stocks
If you really want to buy stocks (I know several people that love the idea of owning a piece of Apple), keep it to a small portion of your total investment portfolio. I try to keep individual stocks around 5% of my total portfolio. Given the volatility and difficulty of trading stocks, it gives me the opportunity to have some fun taking a shot on stocks, but doesn’t risk my retirement savings at the same time.
Invest! Now!
The important part of investing is to get started right away. You need to do so to take advantage of compounding returns that will grow your money the longer you have it invested. Now that you know that you can’t expect 1,000% returns on your investments (even if you are Warren Buffet), that means you have to make up for it by getting time on your side.
If you’re unsure where to start, I recommend checking out I Will Teach You To Be Rich or Your Money: The Missing Manual for an introduction to index funds. If you still need help, you can work with a financial planner to invest in index funds and give up the hassle and complication of dealing with stocks.
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photo by: BlatantWorld.com
I have not owned stocks for two because of the current economy
When others are getting out, you should be getting in. People worry about the economy collapsing too much…they dont invest and let inflation eat away at their savings. In reality, let’s consider that we did have a stock meltdown, and thus an economy meltdown. It would be the end of everything, forget the paper currency, forget the FDIC reimbursing your defunct bank accounts, etc…if things got so bad that your investments would never recover, than you can pretty much assume it’s the end of the world.
I’m going to agree with Justin on this one. I invested 2 years ago in the
middle of the financial meltdown, and returns on mostly every investment I
own have been great since then. I think that if you pulled out or waited to
invest, you’ve already missed an opportunity. Justin is right: when others
are getting out, you should be getting in (there’s a Buffett quote for that
around somewhere).
Does your theory stand for dividend paying stocks? I do DRIP and reinvest for free, and my stocks like ADP and JNJ are pretty solid and have had great returns plus dividends for quite some time.
I’m not arguing that stocks can’t be a good investment. Of course they can,
you just have to choose wisely. For most people, I don’t think they will be
able to pick stocks that will, on average, be able to outperform the market
(and, therefore, index funds) in the long-term.
I agree with not investing in individual stocks and sticking with Index Funds and the like. It seems like a lot of hassle when statistically over time you aren’t going to do much better than the overall stock market, if you do better at all.
Exactly! I like to think of it as a win-win in terms of saving you a lot of
time and hassle while hopefully getting better returns at the same time.
Umm, this is obviously advise given by someone who does not have an education in the matters put forth. How can you begin by saying not to invest in stocks, then recommend investments which have an underlying value resting on some of those same companies?
The computer is not self-aware so I’m not sure where you get the idea there’s no one “getting paid” on the index fund. It’s a lower maintenance account for the institution holding your money, meaning the people overseeing those computers are unable to act quickly on your behalf.
What this will provide the institution is the ability to roll that money again and again into trades which a person wouldn’t normally execute. See the futures market for evidence.
Recognize that these funds are a new concept and not “proven”. Find a professional or get educated.
The act of investing engenders risk. Management of that risk is what you need to look for in both who you invest with and what you invest in.
Thanks, DaTroof, for your opinion. Of course I’m not opposed to investing in companies in general. However, I think that most people, including myself, don’t have the knowledge to choose those companies in a way that is effective.
I don’t buy the efficient market hypothesis, and I have only a very small percentage of my total portfolio in index funds; however, you are right that active investing requires a lot of energy.
I enjoy reading 10-Ks and 10-Ks, no matter how boring they may be. Not for everyone, sure, but where I get my kicks and giggles from annual and quarterly reports, I can’t imagine doing 95% of things other people consider to be fun. If I didn’t like it, I can see why I’d never want to take part in it.
I think your decision to invest only 5% of your money actively makes a lot of sense. More power to you for having the ability to resist the alluring game of active investing. 😛
Thanks, JT. It took learning from experience for investing in stocks to realize it doesn’t work well for me, so I haven’t always been this disciplined.
I’ll be sure to grab a few annual reports for some pleasure reading before I head out for my next vacation 🙂
Well written Jeffrey. I’m a subscriber to the Random Walk Theory on stock investing…youcan’t beat the matket over the long term. I agree, individual stock picking is no way to build a portfolio over a lifetime.