A couple weeks ago I talked about investing in a penny stock.
Since investing in this stock a few months ago I’ve seen a return of over 40%.
When I decided to invest in this stock I had a long list of reasons why I thought it was a good investment. These included financial factors, market factors, and intangible factors (such as the leadership team).
I was also very familiar with their business as I have been a customer for over four years now.
While it’s easy for me to point to my 40% return and say “look, stock picking works!” I could just as easily have lost money. Millions of people have lost money on stocks they thought were sure bets.
With that being said, there are companies in any stock index who are losers and there are stocks that are winners. If you invested in Microsoft or Apple early on you would have made a much higher margin than a total market index. Conversely, if you invested in a company like Borders and held until the bitter end, you would have lost much more than a total market index.
This begs the question: is stock picking bad?
Stock picking can get a bad rap because it oftentimes get lumped with active trading. Active trading can be profitable, but it also comes with a high level of risk. Many corporations are forced to actively trade in some markets to hedge or protect themselves from risk. Individuals can get a piece of the action, too, through some of these active trading platforms.
Active trading looks to profit off of short-term (sometimes milli-second) changes in markets. Stock picking, on the other hand, doesn’t have to be short-term. When I invested in IZEA I had a plan of holding for at least three years, if not much longer. If you believe a company has potential to grow rapidly and take (or create) market share, you aren’t looking for a simple short-term gain.
Some people do pick stocks with the intention of selling on a short-term rise. For example, some investors will invest in companies that are in the midst of make-or-break legal proceedings. People typically avoid these stocks because of the huge risk that the company will go under if they lose. Some investors will take on that risk, though, hoping for a big payday if the company wins the court case.
Let’s assume that we are talking about long-term stock-picking. Many are opposed to stock picking because there have been various studies released that show actively managed funds perform worse than index funds. If actively managed funds can’t even beat the market, how can an average person expect to beat the market?
A counter-argument is that some investors, such as Warren Buffet of Berkshire Hathaway, are able to beat the market by picking great companies and holding them long-term. After all, Berkshire Hathaway has become a massive company and they’ve done it all through asset allocation, which involves a lot of stock picking (which for them sometimes involves purchasing entire companies). Buffet isn’t the only one who invested in the right company at the right time.
After thinking about all the pros and cons of stock picking I can’t help but think it has some role to play for some investors. I will likely continue to stock pick in the future, but only when I find a company that checks off all the boxes (financial, market, and intangibles) and even then I would likely want to know all I can about the business. I will also always keep my individual investing as a small portion of my overall portfolio.
What are your thoughts on stock-picking? Do you invest in any individual stocks?
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I view stock picking the same as I view real estate investing since it involves the same up front skill. It’s not a bad idea necessarily, but certainly not for everyone. This is the reason I hope to keep real estate at less than 50% of my portfolio in perpetuity. Not because I’m bad at Real Estate (well maybe I am), but because the risk level is quite high.
I’ve heard a lot of investors talk about an 80-20 split (80% in Target date funds or index funds and 20% in very risky investments). This seems pretty wise to me (although this doesn’t take into account investing in your own business).
“After thinking about all the pros and cons of stock picking I can’t help but think it has some role to play for some investors” –> Yes. I think the key is “some investors” and not all investors. Right now, I have no business picking stocks (I’m still in a ton of debt and I haven’t made investing a hobby of mine that I can truly focus on and commit to. That said, I hope to be singing a different tune in 5-10 years. I think it depends on where you’re at in your financial goals and what your priorities are. For me, right now, an index fund does the job.
Having seen way too many pick stocks and watch them go up in flames, I’d say it has to be the right investor with the right mindset and doing it with an informed decision. If that’s the case, then it can work out well for you – which there are also many who do it and do it quite well. I do a little stock picking, though like you have a number of things it has to meet first before I’ll consider it. If I had more time I’d probably pick more individual stocks, so I tend to stick us with index funds instead.
Hannah UnplannedFinance Thanks for sharing your thoughts, Hannah. I think you’re right that real estate investing is pretty similar to stock picking. I do think that real estate is more subjected to the overall market, so you could argue that it’s not an apples to apples comparison.
An 80/20 split is fair in my opinion. I think small businesses are a lot riskier of investments than most people think. Then again, many who are risk averse do not typically invest in their own businesses.
Financegirl I’m right there with you when it comes to not having the adequate time to research and analyze stocks. IZEA was a one-off as far as I’m concerned and I’d be surprised if I convinced myself to do any additional individual investing in the near future.
FrugalRules As you probably notice in my past few posts, IZEA was a one-off for me. I would be really surprised if I found another stock in the near future that checked all the boxes. I’m content investing in mutual funds but I’m also open to opportunities – like IZEA – when I see them.
I always say that stock picking is like going to Vegas and putting your money on red, there is nothing wrong with this approach, you just have to know that it’s risky and it doesn’t always pay off for you. However, as long as you take non-core investment money (just as I would suggest taking noncore cash to Vegas) and invest in stocks, then the risk is okay. I have picked stocks for clients in the past and used the same approach for each stock and about half end up being great picks and half end up being losers. Sometimes there truly is no rhyme or reason for specific stocks and you are at the whim of fickle markets/investors with your money.
blonde_finance Great analysis, Shannon. I’m still trying to decide myself how much value there is in stock picking versus choosing index funds. All I know is it’s really tough to say that stock picking is “bad” after you just picked a big winner. But I think you’re right that over time you will have wins and losses, and sometimes there is literally no justification for a stock tanking.