Disadvantages (and Advantages) of Single Stocks

Single (or individual) stock investing can seem like a fun idea – “I’ll be like Buffett and amass an empire using my stock-picking prowess” – but it’s not for most people. It has a ton of disadvantages.

The big disadvantage of single stocks vs mutual funds or index funds is the lack of diversification. Lack of diversity equals more risk. Compared to funds, it’s very hard to put together a diverse (less risk) portfolio of single stocks on the average American salary of ~$50,000 annually.

Most people should simply be using stock funds as their investment vehicle of choice.

In this article, I’ll look at some of the other major disadvantages (and advantages) of singles stocks, I’ll share my simple portfolio, and let you know where to buy single stocks if you want to start building your own portfolio.

What is a Single (or Individual) Stock?

In an effort to raise money for future growth, companies offer shares (a percentage) of their company up for sale on the open market. A single stock is, therefore, one share of one publicly-traded company.

When it comes to investing in single stocks, I’m not referring to owning JUST one share of something. I mean investing in “X” number of shares of one company’s stock (i.e. 100 shares of Google: GOOG).

A single stock portfolio would then be made up of multiple shares of a handful of individual/single companies.

Disadvantages of Single Stocks

I’ve already mentioned lack of diversification. It’s just hard not to have all of your eggs in one basket when it comes to playing with single stocks. Even if you pick ten single stocks to invest in, you’re still subjecting 10% of your portfolio to the whims of a single entity.

Let’s look at some other disadvantages:

You Likely Have Better Things to Do With Your

1. I have other things I want to do with my money first. Some of the things that I rank ahead of purchasing single stocks:

• Completely fund our emergency spending account, which is held at Capital One 360. Right now it’s at the two month’s salary mark. I’d like it to be funded closer to the three-month level.
• Paying off our bad debt as well as our student loans. We’re close to paying off our bad debt, but the student loans would require some extra work and are well below 5% interest. Still, I think going after them prior to individual stocks is the right choice.
• Contribute enough pre-tax money to my 401K and Mrs. PT’s 403B (both of which are in diversified mutual funds) to get the entire company match. We will do this in 2008.
• Max out our allowable annual contributions to these pre-tax funds. We will also do this in 2008.
• Max out our available IRA (invested in mutual funds) contributions. I don’t know if we’ll get this far or if we’ll be eligible, but it’s definitely a stretch goal for us.
• Saving for a couple of nice vacations.
• Giving more money away.

2. Even if I were to complete all the above and had money to spare I simply don’t think single stocks are necessary for my retirement portfolio to do well. We’ve got it covered when it comes to retirement savings by focusing on a heavily diversified portfolio. By this I mean, we’ve got our money in mutual funds that spread our money out over many stocks in many different markets. We’re earning solid returns without the risk that comes with singles stocks.

3. I don’t know enough. Investing in a single company with a lot of your money requires that you (a) know a lot about that company or (b) like gambling. Although, in my opinion, know matter how much you think you know, it’s still kind of like gambling to put all your eggs in one basket. I just don’t know enough about a single company to make it doable.

Do you invest in single stocks? If not, do you see yourself owning shares of a company one day?

I think it’s a question a lot of people have. Very similar to my recent post about moving into taxable investing. However, this question relates more to the type of investment vs the investment vehicle. Most of us are in stocks via our mutual funds, target date funds, and index funds. But how many are into single stocks as well?

Reasons to Own Single Stocks

Why would you even want to own single stocks? We now have all types of investment options (target-date funds, mutual funds, index funds, etc.) that are designed to remove the risks involved with single stocks. So why would anyone want to own single stocks?

There are a few reasons single stocks make sense for some people:

1. Company Stock – If you work for a company, you may have been given shares or options to buy shares of your company’s stock. This is great. And it’s excellent that the company wants you to own and invest in part of the business. If you’re lucky enough to own shares through a company stock purchase plan, I’d encourage you to explore ESPP flipping.
2. For Fun – Investing in mutual funds is about as exciting as watching paint dry. I talk a lot about maxing out your retirement accounts and starting up Roth IRAs. And I can see the collective eyes glazing over each time I do. I get it. It’s not exciting. That’s why I think some people turn to single stock investing. They see it as a way to do some real, hands-on, “stuff I can wrap my head around” investing. For instance, owning a share of Blockbuster stock is fun because you can walk into the store and use their service. You can invest your dollars in the company you own part of. Fun.
3. You’re Comfortable with the Risk – Another reason to invest in single stocks is because you’re comfortable with high risk. I’m not a risky guy. Single stocks aren’t for me. But I know there are plenty of 20, 30, and 40 year olds with cash out the wazoo who are looking to gamble on some companies. Nothing wrong with that if you’re fine with the risk.
4. You Can Create Your Own Allocation – Some people actually have the investing savvy to set up proper asset allocation with their portfolio using nothing but single stocks. These people are able to achieve with 50 stocks, for instance, what you are getting with your mutual fund. If you are the type that can set this up and actively manage your stocks, then go for it.
5. Dividend and Strategy Investing – I don’t know much about this topic, but I do know that some people like to invest in single stocks because of the dividends they produce. Or they use some other investment strategy that leverages the power of singles stocks. It’s my goal to know more about these strategies in the coming year.

Risks Involved with Single Stock Investing

As I alluded to above, there are some risks involved with single stock investing. The primary risk (compared to other investment choices) is that you aren’t able to easily achieve proper asset allocation (i.e. you have all your eggs in one basket). If the company you are invested in goes bankrupt, the stock price will tank, and you will lose your money.

Limit Your Single Stock Investing

Because of the risks involved with single stock investing, it’s often recommended that you keep your single stock ownership to around 10% of your entire investment portfolio. I pretty much agree with this philosophy. But I’m a very risk averse guy, and the primary reason I invest is to save for retirement. I don’t consider myself savvy enough to beat the market with my picks. Maybe one day I will be though.

Where to Buy Stocks

The best place to buy single stocks if you’re going to be actively trading them is at one of the best online stock brokers. These companies allow you to move your money around in and out of stocks with little or no fees. You don’t want expensive trading fees to cut into your single stock profits.