5 Ways to Get Comfortable with the Risks Involved in Single Stock Investing

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.

1. Diversify

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!

2. Limit Your Exposure

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.

3. Keep Fees Low

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.

4. Remove the Risk

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.

5. Get Education

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?

About the Author

By , on May 24, 2010
Phil Taylor
Phil Taylor is the author of PT Money, a personal finance blog about saving money, making extra money, credit cards, coupons, living frugal, debt payoff, and more.

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Leave Your Comment (8 Comments)

  1. Steves says:

    i’m a small time investor too, and agree that 10% of your portfolio in single stocks is fine, especially if you are just starting out. i actually got my brother in law interested in it too. my father used to invest a lot in single stocks in the late 90’s when it was popular, that’s how i first started. any books you’d recommend on the topic? or other websites?

  2. CTA says:

    if i invest in single stock, i will choose Options investing

  3. PT says:

    Hi, Ken. Anything invested in the stock market (i.e. mutual funds) have the potential for huge swings in returns from year to year. I think 2008, the market average was in the -30%, and then it turned around to +25% in 2009. You never know from year to year. However, I think mutual funds in general have returned anywhere from 6% to 10% over the past 30 years.

    CD ladders are a great place to start. There is little to no risk with a CD though. They are FDIC Insured. So, your reward is limited.

  4. Ken says:

    great article, thank you for it.i’m a novice, small-time (20k) investor.my question if you have the time, how much of a return should you reasonably expect from a mutual fund?in terms of APY if possible.im not sure of all financial terms yet.i put about 1/4 of my portfolio into CD ladders.just as a way to start off slowly in the investment world.my best rate is at 3% APY

  5. Life McGowan says:

    Everything we do, every opinion we have, all takes a risk. Dealing with it needs a lot of effort and emotional stability. Investment takes prior risk management in order to gain a very distinct outcome that may provide a positive outlook. Having a diverse knowledge on your investment keeps you tight in dealing with possible negative effects.

    Single investment provides a lesser task and managing effort thus, the risk are also minimal. The control of investment is adjustable and the operational flow is more stable.

  6. PT says:

    @charles – yes. 10% max in stocks is the rule of thumb.

    my retirement account asset allocation is like this: 80% mutual funds, 10% bonds, 10% cash

  7. charles says:

    wow 10% of the entire portfolio should be in stocks? that seems a little low. can you provide a breakdown of other investment categories in a portfolio? how much in mutual funds, bonds, etc in a portfolio? thanks.

  8. Donny says:

    I prefer to do options investing when investing in single stocks because it is more risk more reward involved in them

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