Trade In Your Speculation Money For A Diversified Portfolio
I was with a friend the other night who asked me to tell him what the best “stocks” were to invest in right now. My friend thought that because I work as an advisor at a wealth management firm, that I was hoarding a secret list of investment opportunities just waiting to be exploited for financial gain. “Come on, tell me,” he asked repeatedly (this person had a couple of drinks, but it was Friday, so we’ll give him a break). Through the incessant chatter, I got around to explaining to him that trading individual stocks is not what I do for my job. If that strategy was reliable, perhaps I would be trading in my own account for my day job.
Drinks aside, this friend was certainly not the first person to ask me this question. I would estimate that almost anyone who has been in the business of giving financial advice for at least a year has been asked this question – probably even by their uncle one week after they got the job. Frankly, this outlines a common misperception in the financial advisory industry today. The days of the stock broker – who used to have (or claimed to have) the answer to this very question, are dwindling by the month.
What I’m about to speak to is in the context of my friend above, and many others who are looking to make some money relatively quick in the stock market by getting in on the next big thing. A lot of them have had the misfortune of constantly hearing from the neighbor at their amenity-ridden apartment about the massive amounts of money they made on Bitcoin or Netflix over the past year or two; prompting them to want to jump in to the market so they are not left behind.
In my opinion, unless you are financially free or close to it (i.e. work is optional for you), purely speculating on individual companies is an activity that should be done only with money you wouldn’t mind simply going to the casino with and losing all in one night. Why? Because there is a much more reliable way to invest your money in the markets and create wealth. By speculating, I mean buying a company based solely on a current trend you hear about, an article you read, or anything that falls short of doing at least a few hours of personal quantitative and qualitative research.
For younger people, this “casino” amount might range from a few hundred to a few thousand dollars. Further, investing a couple hundred or even a thousand dollars in one company really isn’t that great of an idea anyway because of the time it would take to achieve the kind of return the person I have unfairly profiled in this blog has in their mind, especially net of the trade commission you might be paying on each side of the transaction. For example, if you pay a $10 transaction fee to buy $1,000 worth of Apple, Inc. stock, you are already down 1% going into the position. I understand that isn’t much, but it’s also not negligible and is hardly considered.
At least at the casino, doubling or tripling your money in one night isn’t all that uncommon. Playing stock market trader, as cool as it may sound, is difficult for the average individual because to consistently make money usually takes a lot of time and discipline, let alone an actual due diligence and selection process. Unfortunately, just hearing on the news that marijuana was made legal in Oregon is not a great reason to go purchase a “promising” Portland based cannabis company.
That said, individual stock picking is difficult for anyone, even the professionals who do so in the context of a portfolio. According to most recent SPIVA statistics, some 84% percent of large-cap active mutual fund managers failed to beat the S&P 500 over the past five-year period ending December 2017.
Put another way, MOST professional money managers who pick stocks, failed to “beat the market” that year. It’s also worth highlighting that these managers are picking large cap stocks – which have the most available information and are the most widely followed. When it comes to small-cap companies, that percentage only gets worse, with 91% of managers underperforming their benchmark over the same period. This is a reality everyone should keep in the back of their mind when hearing someone talk about their own stock selection prowess.
My goal here is not to discourage anyone from investing in individual stocks and I do not fault my friend for asking – who wouldn’t want to know which companies could potentially provide them with a huge return? However, the fact remains that investing in individual stocks over the short term is a very difficult task without a sound process that can be implemented and monitored with discipline. While you might get lucky with the occasional “ten-bagger” (credit to Peter Lynch for the term), research has shown that a low-cost, well diversified portfolio of funds managed in a tax efficient manner will provide you with the best opportunity to preserve and grow your money. This is the kind of investment framework we create for individuals and families at The Johnston Group. With a little bit of patience and focus on a longer time horizon, you can put your speculation money to work for you and build something much more meaningful.
To those who have and continue to make money picking individual stocks, I salute you. If you have only made money picking stocks dating back to the start of the current bull market we're in, I give you a sincere golf clap and wish you continued good fortune.
Picking stocks is not for everyone. But investing in the financial markets is possible for everyone and so is a good investment outcome provided the right structure is in place. If you are young, you have the most to gain by implementing a sound investment portfolio to save into – Father time is on your side and he’s best buddies with dividends and interest. If you are not so young or are not yet financially free – a sound investment strategy is even more crucial.