The Perils of Investing in Individual Stocks (Bestie Ep) #767
Dec 27, 2023
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The podcast discusses the risks of investing in individual stocks and emphasizes the importance of diversification. They address common concerns and argue against this investment approach. They also discuss the disadvantages of investing in individual stocks, such as higher taxation rates and potential losses. The hosts caution against investing in single stocks of your employer or companies in your industry. They highlight the dangers of overconfidence and stress the importance of accurate record-keeping. The podcast also explores the benefits of Airbnb and discusses the importance of simplicity in investing.
Individual stock investing is often driven by luck and can give a false sense of abilities.
Trying to outpace the market with single stocks leads to poor investment decisions and underperformance.
Diversification through index funds offers more consistent and reliable long-term returns.
Deep dives
Reasons to Avoid Single Stock Investing
Single stock investing is fraught with risks and challenges. Most stock pickers, even professionals, consistently underperform the broader market. The allure of picking individual stocks is often driven by luck and can give investors a false sense of their own abilities. The volatility and unpredictability of stock prices make it difficult to time investments, and even successful picks can quickly turn sour. It is hard to differentiate between skill and luck in individual stock investing, making it a dangerous endeavor for most investors.
The Importance of Average Returns
Investors often chase better-than-average returns, but average returns can still lead to significant wealth building over time. Trying to outpace the market carries significant risks and can lead to poor investment decisions. The average returns of index funds, such as the S&P 500, are more predictable and historically have been around 10%, while last year saw a return of almost 30%. Swinging for the fences with single stock investing introduces unnecessary risks and often leads to underperformance.
Diversification Leads to Success
Diversification is a winning strategy when it comes to investing. Funds like total stock market or S&P 500 index funds offer broad diversification by investing in hundreds or thousands of stocks. Owning a diverse basket of stocks ensures that investors participate in both winning and losing companies. While individual stocks may offer the potential for greater gains, they also expose investors to the risk of significant losses. Diversification mitigates those risks and offers more consistent and reliable long-term returns.
Investing in individual stocks is risky and often leads to underperformance
Investing in individual stocks and trying to beat the market is a common strategy, but it consistently fails. Investing in your own employer's stock or buying stocks in your industry is not advisable due to lack of diversification and biased decision-making. The argument of investing in what you know is flawed because being close to an industry can cloud judgment and limit perspective. Additionally, timing the market and knowing when to buy and sell individual stocks is challenging and often leads to poor outcomes. The recommendation is to invest in index funds for a more diversified and consistent approach to investing.
The importance of simplicity, diversification, and average performance in investing
Investing should be simple and not require excessive time and research. The lazy approach of investing in index funds allows for average performance, which is often better than actively picking individual stocks. While some may enjoy investing in single stocks as a hobby, it is recommended to limit exposure to a small portion of the overall portfolio. The focus should be on foundational personal finance steps, such as paying off debt and building an emergency fund. Timing the market is difficult, and investing in a few companies requires more risk and attention, whereas index funds offer simplicity, diversification, and better long-term performance.
Think about the last novel you read that included a dangerous quest. If it’s a fantasy like the Hobbit, there might be giant spiders, goblins, and dragons- but in the end, it’s worth it because of the unfathomable treasure and riches that await them. The thing is, when we’re talking about investing in single stocks, the chance that this perilous journey ends up with a happy ending is much less likely, but folks continue along in their quest. Why? Maybe it’s because of the sophisticated tools that we have at our fingertips, or because it’s more accessible than ever with apps like Robinhood where you can buy and sell for free, or maybe you just think you’re smarter than everyone else. And sure you’ve heard of individuals who have crushed it by investing with a company like Tesla, but we’re still not fans of this type of approach. So in this episode we tackle some of the most common arguments advocating for investing in single stocks, why we ultimately disagree, and how you should invest your money instead. Single stock investing is unnecessary and can often be problematic.
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