Individual Stocks or Funds? Which Should You Invest In?
Many investors feel the lure of stock picking. Buying shares in the companies you see a bright future for can certainly be exciting and can come off. The world’s most famously successful investors, people like Warren Buffett and George Soros, have made their fortunes by being good at judging which companies will see their share price rise over the years.
But is trying to pick stocks a good idea for the average investor with a portfolio? Or does it make more sense to leave it to the professional fund managers or just go with a passive fund that tracks a major index like the FTSE 100?
Investing In Funds Compared To Stock Picking
It is too simplistic to say that the average long term investor should not try to pick their own stocks. There are arguments in favour of doing so under the right circumstances. But the broadly accepted wisdom is that on the balance of considerations, most long term investors may see more stable results from sticking to funds.
So what are the strengths of funds as an investment vehicle for the average investor? Why is the conventional wisdom generally to take this direction rather than try to build a portfolio from individual stock picks?
Actively managed funds pay teams of professionally trained analysts to screen hundreds and thousands of stock market-listed companies for signs their share prices have the potential to grow. And their job also involves balancing the combination of these shares in a way that offers the best chance of success, and limit to losses, under different possible circumstances. An individual investor considering stock picking should ask themselves the question why they believe they would do a better job.
To help them analyse individual stocks and the balance of risk between them, the teams behind funds also have access to market data and specialist software. There are now online products that offer similar software to individual investors. But these come at a cost. It might not be huge but is usually enough to meaningfully eat into the annual returns the average investment portfolio might be expected to achieve.
Of course, actively managed funds also come with costs in the shape of fees. These can, if the fund doesn’t perform particularly well in comparison to the market, also have a negative impact on long term returns.
Another option is a passive fund that tracks an index like the FTSE 100 or FTSE All-Share. These funds have much lower fees, also offer diversification and have historically actually performed better than a majority of actively managed funds after fees are deducted. Which just goes to show how difficult stock picking is!
An actively managed equities fund or passive index tracker will normally hold tens of stocks. And in the case of an actively managed fund this selection process isn’t only performed once. Analysts and the manager regularly adjust their fund’s investments to take into account changing market conditions. For an individual investor, doing that ongoing research and analysis would involve a serious time commitment. As well as the question of whether that is practical it also means an opportunity cost. Is it worth the leisure or earning time given up?
A Smart Approach To Stock Picking Portfolio Allocation
All of the above is not to say private investors should never consider picking their own stocks. One advantage to dabbling in personal stock picking is that by educating themselves how and going through the process, an investor will usually get a better understanding of how investment works. That can be an advantage and lead to better informed decisions on which funds to invest in.
If, having weighed up the pros and cons, you are inclined to try and pick your own stocks, it can be done without seriously compromising the level of risk your investment portfolio is exposed to. You could set aside a modest percent of the total you will invest to individual stock picking. If it goes well, great! And if not, you won’t have badly compromised your long term returns and will have learned some investment lessons that will be valuable in the long run.