We are at an unprecedented time right now as regards the stock market.
Not only is the market as a whole at its all time high, but individual stocks like Amazon, Apple and Tesla are breaking new records as well.
Whenever you turn on the news, you are bombarded with news about people who are making a killing picking the right individual stocks.
So if you aren’t investing in hot individual stocks you feel like you are missing out.
Isn’t this what real people do? I want to be rich one day, so I should follow suit right?
This is where I want to stop you and explain several really good reasons why you should take a pause and think really hard before you go out and buy a load of Tesla stocks.
1 – Individuals Are Just Not Good Stock Traders
Brad Barber and Terrance Odean are two Behavior Finance Professors from UC Davis and UC Berkeley who have done some extensives studies about the Average Individual Investor.
Their research demonstrates some pretty interesting and consistent findings about the average investor.
When it comes to investing decisions, if we are guaranteed to do one thing, it is to make the wrong call.
- We believe that we are ahead of the trend, when in fact, we are chasing them.
- We buy when the market is going up and sell when it is going down. There is no better way to lock in your losses. Talk about kicking you when you are already down.
- We get too caught in past performances and make decisions that coincide with our emotions rather than logic.
And by holding undiversified stock portfolios, we underperform the standard benchmark.
Yes, I know what you are thinking. How do you explain my friend who knew to buy Google 10 years go? Don’t get me wrong. People do his occasional home runs. But studies show that less than 1 percent of people have the ability to consistently and regularly beat the market.
So if you think you have the ability to beat the market, you should ask yourself the question.
“Are you Warren Buffet?”
If not, I would put my money on trying to keep up with the market rather than trying to beat it.
You might be thinking of another question. “But, if we can’t beat the market, why are so many investment firms and brokerage companies sponsoring classes about active trading and options? If I can’t beat the market, why are they saying they could teach me to do it?”
Good question. It’s because they are incentivized to get you to believe that you can. And these incentives are worth hundreds of millions of dollars. When you trade or make a bet on the market through their platforms, they make money by charging you per trade. Whether you win or lose, it doesn’t matter. The house always makes their money.
2 – No One In The Media Knows A Stock’s Future
Let me tell you another good reason you should pause before you start trading individual stocks.
No one in the media knows a stock’s future.
If you’ve been around the investing world long enough, you might know this guy.
Mr. Jim Cramer. The host of Mad Money on CNBC.
If you are not familiar with him, he is the guy who will give you stock tips on his show. He is also a former hedge fund manager and was ranked No. 35 on the list of top 100 money managers by “Forbes” in 2008. Pretty impressive resume I must say.
But, shows like Mad Money and thousands of other media outlets like it are spreading the toxic and false message that playing the stocks is easy and fun.
And they have good reason to. Many of these media outlets’s entire business model is based on encouraging individual stock picking. CEO’s come on to discuss why viewers or listeners should invest in their companies. Analysts appear reinforcing the recommendations. And convinced by their cover of professionalism, we as individual investors come to believe these “expert” analyses of individual stocks.
We are duped into believing that we too can understand company and market fundamentals. And armed with this knowledge, we too can read the fortune cookie and make money.
And these media outlets don’t care if you make money or or lose money on your investments. All they care about is their ratings and audience retention. Ratings bring in ad revenue. And do you know who most often are buying these ad slots? Companies that want to sell you financial products. Banks, Investment Management Companies, Trading Platforms.
No one in the media knows a stock’s future because they don’t care about accuracy. All they care about is getting your attention. And if they can make you believe that you can win trading stocks, that’s what they will constantly do.
Have I scared you enough yet?
3 – And If Someone Knew For Some Reason, Do You Think They Would Share With Us?
Let me give you one more reason why you should take a pause before buying individual stocks.
Let’s say that someone really did know what a stock was going to do. He or she has figured out the golden formula for predicting the future.
What do you think this person will do? Go out on Jim Cramer’s show and lay it all out? Post his or her findings on a Reddit forum? Or start a YouTube Channel to share his or her secret formula?
The bottom line is, do you really think he or she would really share it with us?
This person would likely invest that idea, make billions and move to a tax-free tropical island living his or her days on a yacht.
And worse yet, if he or she did find out what direction a stock was going to turn via confidential or non-public information and profited on that fact, there is a financial term for that. It’s called “Insider Trading.” And it’s illegal.
So, When Is it Ok to buy individual stocks
After all this you still want to dabble individual stocks. I would actually say that is ok. Because that is how many people feel.
And you shouldn’t feel guilty about it.
As long as you follow a few strong guidelines around it.
A good way to think about individual stock investing for me is to think of them like cheat meals.
Let me explain.
In order to maintain a healthy body, when we eat, we should stick with nutritious whole foods: A lot of vegetables, lean protein and unprocessed carbs. This should be the staple of our diet.
But tell anyone to live off only chicken breast, broccoli and brown rice and you’ll have a riot on your hands.
I like to think of cheat meals as individual stocks and the main nutritious meal plan as index funds.
Like a healthy meal plan, nutritious whole foods should make the core of our diet. Majority our meals should come from unprocessed whole foods. But in order to ensure we stick to this meal plan, we should indulge ourselves in cheat meals once in a while. Not too much, maybe one or two times a week.
These cheat meals actually help us to stick to our healthy diet, not keep us from them.
If you have desires to buy and sell individual stocks, make sure you treat them like cheat meals. They scratch an itch and help you to stay the course, but they shouldn’t be the core foundation of your investment holdings. The core foundational holdings should be low cost index funds.
If you want to purchase individual stocks and test your stock picking abilities, set yourself a percentage limit. I’d recommend no more than 5% to allow yourself to dabble in the market with individual stocks you might feel strongly about.
But again remember, index funds should be the mainstay of your portfolio. Individual stock picking’s purpose here is to help you maintain that core holding, not detract you from it.