As a CPA, I’ve done several tax returns over the years. One thing I got to see when calculating capital gains and losses was what type of investments people were into. I saw a lot of portfolios made up of 5 to 10 single stocks. It shocked me that so many people were putting a great deal of their money into just a handful of investments.
Over the years we’ve learned that investment risk can be greatly reduced by avoiding single stocks. And investment houses have responded by giving us more diverse products, like the mutual fund. With these diverse funds, we can limit our investment risk. While we still have to deal with market risk, it’s good to know that we don’t have as much individual investment risk.
Still, some people like to take a chance on a higher return and go with single stock investing. If you’re dead set on adding single stocks into your portfolio, here are a few tips for getting comfortable with the risks.
What I did like about most of the portfolios I saw in the tax returns was the variance of industries and business sizes in the list stocks. Just like with any investment, you want to diversify as much as possible, even within the investment itself. Since you can’t break down a stock into further pieces, you need to focus on creating a diverse set of stocks. To achieve this you’ll need stocks from different industries, stocks of different sizes (i.e. growth vs income), and stocks of different countries. How many stocks is enough? Some say as much as 30!
A good rule of thumb is to keep your single stock ownership limited to only 10% of your entire portfolio. The rest should be in naturally diverse investments like mutual funds, exchange-traded funds, and bond funds, as well as other investments like cash, real estate, and commodities. Therefore, if your entire investment portfolio is valued at $50,000, only $5,000, at most, should be in single stocks.
If you’re going to be trading single stocks more actively, you need to be with an investment house that won’t charge you an arm and a leg each time you make a move. Sometimes the risk of expenses can be a danger to your performance. Pick from one of the best online stock brokers available today.
This strategy is only available to a select few, but if you have a company employee stock purchase plan (ESPP), you may be able to do this. Some ESPP’s allow you to flip the stock you purchase immediately after making the purchase (which is usually granted at a nice discount). This quick ESPP flip allows you to completely remove the risk involved with investing in your company’s stocks. If you have this option, grab as much of this as your company will allow and your budget can afford.
Last, and certainly not least, do your research. One of the benefits of single stock investing is that you can study the balance sheet and income statement of the particular investment. Whereas mutual funds, you can only study the performance of the fund manager. Learn which financial ratios are important. Study them. Compare the company’s performance to their peers. Study the industry they are in. Go to the stock holders meetings.
What do you think of single stock investing? Do you use it in your portfolio?