Stock Picking Pros and Cons: Should You Buy Individual Stocks?

When you invest in the stock market, you’ll need to be aware of the investment risks. It’s also quite important to invest with your eyes open: to make sure you do enough due diligence before buying equities and putting your money to work in the stock market. While you are making your money work for you, you’re also exposing it to some risk after all. So tread carefully: do the research needed to pick the right stock investments. Now because there are so many stocks in the stock market universe to choose from, making investment choices can sometimes be rather daunting.

Should You Buy Individual Stocks?

If you do decide to pick individual stocks for your investment portfolio rather than to invest in good mutual funds, then you’ll need to be aware of the process involved in making stock picks. First, you must decide what you want to invest in: are you looking at a specific stock sector or company? There are several factors that you’ll need to look at:

1. Check stock and company performance.
When you’re evaluating a stock, check out its company’s performance in its given industry (or space); and also check on the historical performance of the stock itself. Check the following measures carefully:

• The stock’s P/E ratio (or price to earnings ratio) which tells you just how overvalued or undervalued a stock happens to be.
• The stock’s dividend yield, price-to-book and price-to-sales measures. Higher yields make a stock more attractive.

2. Gauge the state of the economy.
The economy can have quite the impact on companies, despite how the company itself may be performing. In recent years we have seen and heard companies claim that they’ve been performing well only to later witness these businesses decline in the face of a poor economy. Unfortunately, because of exogenous factors, it’s not unusual to come across companies that aren’t able to sustain themselves months or years after touting a good performance. They may blame the economy for their situation, and rightfully so.

3. Take a hard look at the company behind the stock.
Take a hard look at a business and determine how solid it is, fundamentally. You also need to look at their sales, revenues and profit margins. If a company is showing a decline in these measures, then you may want to think twice before buying their stock.

Stock Picking Pros and Cons

Whether or not you’re building a retirement portfolio, it’s good to be aware of why you’d want to buy individual stocks rather than mutual funds and other simpler investments. What are the pros and cons of picking your own stocks?

The Pros
If you develop your own individual stock portfolio, you:

• Know exactly where your money is invested in. By choosing your own stocks, you control your investments at a greater level.
• Learn more about the stock market and how it works, as you do your research of possible investments.
• Can do well and become highly rewarded with a more concentrated portfolio of individual stocks than you would with a diversified set of good mutual funds.
• Can have the satisfaction of selecting the stocks you like and enjoy. You may be a happy customer of a company like Apple, for instance, and you may want to own a piece of one of your favorite companies as a direct shareholder.

The Cons
The cons of stock picking include the following considerations:

• There are greater risks involved with managing individual stocks. You’ll now face specific company risk along with stock market risk and stock sector risk. If the company that your stock represents faces any trouble, you’ll feel a bigger impact from these developments than you would if you simply owned mutual funds.
• A concentrated stock portfolio can yield both higher risks and higher rewards. You may be prone to greater losses if you decide to pick stocks yourself and may face more volatility with individual picks than you would if you own a fund.
• Are you trying to beat the market? If so, it’ll be hard to do this if you aren’t a stock picking expert.
• Stock picking takes up more time than passive investing in index funds does.
• You don’t have the support and assistance of financial professionals who do the job of selecting stocks for you.

Some investors end up consulting with professional stock brokers to help them pick their stocks based on their risk profile, their budget, comfort zone, and any other factors that are important. Others prefer to focus on investing in mutual funds, and there are others still, who prefer to pick their own stocks because they’d rather put in the effort to research and make decisions themselves on certain stocks that may have captured their eye. So which approach is right? My opinion is that there’s a place for all investment strategies: there’s always room to diversify with mutual funds while dedicating a portion of your portfolio to individual stocks so that you may indulge your stock picking activities. I would personally keep between 4% to 20% of my portfolio in individual stocks, while the rest is invested in funds. That way, I get the best of both worlds while making sure I manage my risks!