7 ½ Reasons Why You Should Invest in Individual Stocks

Only 15% of US households own individual stocks. This figure has not changed much since the early 60s. But there are many good and important reasons to invest a portion of your assets in individual stocks. Here are 7.5 of them.

1—You get the lousy with the great. In a typical year, just 25% of stocks account for the majority of gains in the market. Investing in a diversified/index fund guarantees you own some of the top performers, but also guarantees you own many of the losers, resulting in average performance.

2—You will never beat the market. People can toss their investment money into index funds, sit back, and simply match the market. But you’ll never beat the market.

3—When everyone gets on the same side of the boat, it tips over. Active fund managers look for a needle in a haystack. Index fund managers buy the whole haystack. The biggest danger of index funds is when most people do it. When the majority of people avoid thoughtful, individual stock selection, there is even more opportunity for investors who pick individual stocks.

4—You sacrifice returns for safety. In the past 50 years, employers have changed from pension plans to 401Ks and IRAs. This has shifted investment decisions to the individual. Unfortunately, most individuals lack investment training and feel unprepared and end up fleeing to the average performance of index funds. But too much risk avoidance leads to return avoidance and stifles capitalism.

5—The dark side of index funds. Diversified/index funds use mostly mechanical criteria and rules in selecting stocks—making them mostly momentum funds. Momentum funds buy more of stocks that have been performing well recently. This passive, follower strategy works best in a rising market. In a falling market, diversified/index funds stay fully invested and continue to buy more of stocks that are not performing as badly as the rest. The mechanical nature of diversified/index funds makes them ill-suited for making above average returns.

6—Top performers will more than compensate for a few poor performers. With a disciplined approach, it is possible to invest more in gainers than losers. Stock returns are lumpy, so in a portfolio of 10–15 stocks, 1–2 will likely do extremely well, 3–4 will perform good, 6–7 will be average, and 2–3 will perform poorly. Uncertainty or risk around how individual stocks will perform is the ante required to earn higher-than-average returns.

7—Take a stand on how you want the world to work. Part of owning individual stocks is taking a stand on how you want the world to work. Investing in stocks requires a leader mentality and that you be a steward of society’s assets. By influencing the movement of capital to its most productive use, an individual investor enriches him/herself and improves the human condition. This is similar to the duty of voting in a democracy. Being a voter and investor are adult responsibilities.

7.5—Finally, a cynical way of thinking about index funds is that people investing in them believe thinking is a waste of time.

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Check out polarisinvesting.com. You’ll sleep well at night knowing you made a thoughtful decision.