Should you invest in stocks?

This past weekend I went to an investor fair sponsored by the Chicago North and West Chapters of BetterInvesting. These are the people who used to be known as the National Association of Investment Clubs. I write a quarterly column—Fund in Focus­­—for the magazine, and the occasional cover story. But like so many relationships these days, mine is virtual so it was nice to meet some of my fellow authors (and they are nearly all fellows, which is a bit disappointing).

They tend to be an engaged and savvy group. Maybe this is the product of self selection, because if you’re disinclined to put in the work a stock study requires, or regularly lose money, you probably wouldn’t stay with a stock investment group. But the people I met had a pretty good understanding of risk, had seen some investments lose a lot (and gain a lot), and generally asked thoughtful questions. No one seriously supported day trading, told me about the latest greatest penny stock, or was wearing a tin foil hat. I was heartened to see more than a few young people.

Buying individual stocks is not something I recommend to my clients. I strongly believe that the essence of investment planning is establishing and maintaining a core portfolio allocated among a wide variety of asset classes (e.g., large cap, international, natural resources, etc.). Depending on how much money you have to invest, how risk tolerant you are, and what options are offered in your accounts (and 401ks may be quite limited), you might choose a whole clutch of funds, or one target fund, or something in between. This is where most of your, and my, investments should be because most of us don’t have time to monitor investments day to day (and probably shouldn’t) and because it offers you a prudent combination of risk and reward. You’re never going to make 300% in a year or two on mutual funds, but you’re not going to lose every red cent, either. You can do both, or either, investing in individual shares of stock.

What I love about BetterInvesting and all the information, analysis tools, and opportunity to benefit by others’ thoughtful opinions is that there’s some basis for making judgments. Most people pick stocks because their brother-in-law told them about it, their kid likes the product, or their husband sat next to an executive of the company on a plane (which is why you cannot mention the name Ciena to me).  Or they’re told “buy what you know” or (shame on you Peter Lynch) go sit in a mall and watch what stores get the traffic. Which is a good way to end up with a whole portfolio of consumer cyclical stocks. And no, that’s not balanced or…wait, I’m foaming at the mouth.

I have seen the occasional client who thoughtfully bought and sold individual equities, and done quite well. But like the owners of apartment buildings, they’re often tired of the stress and want to reduce at least some holdings. Many people have inherited stocks, or fallen in love with a company, or are hoping to get back even on a loser, or reluctant to sell a winner because it might go higher. So BetterInvesting methods really shine not only in stock picking, but if you actually learn the methodology, in identifying when you should sell.

Which investor should you be? Probably, you should be what Benjamin Graham (Warren Buffett’s mentor) described as the defensive investor—seeking to maintain and grow a portfolio at a prudent rate, getting return while balancing risk. After all, most of us have enough trouble wading through and understanding the offerings in our 401k, although now at last the reasonably diversified target date funds are becoming the default.

But Graham also describes another kind of investor—the enterprising investor (which Warren Buffett surely is). As Graham so concisely puts it, The rate of return sought should be dependent, rather, on the amount of intelligent effort the investor is willing and able to bring to bear on his [sic] task. If you’re willing to put the time into study and monitoring, and have the intestinal fortitude to ride out terrible markets and make courageous choices, you might actually be that 2 or 3 in 100 who should consider some enterprising investing.

I like to divide portfolios (including mine) into “core” (asset allocated mutual funds) and “casino”—or maybe there’s a nicer name like adventure or enterprise. Keep that casino portion small (maybe 10%) of your total holdings, and ask yourself these questions:

  1. Could I stand it if I lost 50% of my investment’s worth? 100%?
  2. Would I sell everything in a bad market, hold on, or buy more? (Buy more is what an enterprising investor would do. A defensive investor would hold on.)
  3. Have I read a good core of basic books on investing? (Malkiel, Graham, Bernstein)
  4. Do I have rules for myself on what constitutes an acceptable stock to purchase, hold, and when to sell?
  5. Do I have time to continue to study, research, and monitor the portfolio?
  6. Can I trust myself to follow up regularly over years?
  7. Do I understand what conditions might make my investment go up or down? Buffett famously said he did not understand tech companies and so avoided the bubble in that sector by not buying them in the first place.
  8. Do I have a way to discuss ideas with other thoughtful investors (and I don’t mean a bunch of internet trolls or Jim Cramer)? Besides BetterInvesting and investment clubs, it might be worth checking out the American Association of Individual Investors (no personal experience) and groups such as the Bogleheads.
  9. Do I need this money in the next 5 years?
  10. Am I desperate for money? STOP, that was a trick! If you are, stock speculation is a sure way to make yourself even more desperate.

I don’t advise my clients on individual stocks, except to recommend they diversify into mutual funds if their individual stocks constitute too much of their total investments. I think it’s an art and a very personal interpretation, and ultimately you know the success of your judgment by your own results. Even in an investment club with people looking at the same data study, the opinions on worth will vary greatly. BetterInvesting has said for years that for any five stocks you pick after careful study and evaluation, three will do about what you expect, one will do far better, and one will tank. That’s been about right in my experience, but it can be a pretty nerve wracking ride. You always remember the ones that tanked, but you only talk about the ones that did well.

Only fall in love with things that love you back.

About the author

Danielle L. Schultz, CFP®, CDFA

Danielle L. Schultz, the principal financial planner of Haven Financial Solutions, is a CERTIFIED FINANCIAL PLANNER™ (CFP®), a NAPFA-registered Financial Advisor, and a Registered Investment Advisor in the State of Illinois. She studied financial planning at Northwestern University’s Certified Financial Planner™ certification program. She also holds a Series 65 license (Registered Investment Advisor Representative) and a CCPS (Certified College Planning Specialist).

She writes a regular column for Better Investing magazine and is currently working on a revision of their mutual funds handbook. In addition to academic training and professional experience, Ms. Schultz has personally managed Social Security, Medicare, retirement and long-term care issues; college funding concerns; and cash flow and transition planning in self-employment and divorce situations. Her social work background gives her an innovative perspective on financial planning issues; for her, financial planning is not only about money, but also a key component in a satisfying and well-lived life.

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