Many of us enjoy investing in stocks. Let’s face it: Selecting successful stocks can be a fun exercise. Some of us like to “buy and hold” stocks so we can watch the firms grow and prosper. Others trade frequently — trying to outguess the pros.
No matter your personal stock buying/selling style, Tilly believes it is all good. Here are five thoughts about how Tilly advises our clients who desire to purchase stocks.
- If you enjoy owning stocks, consider playing the market with a small percentage of your investable assets. We suggest thinking about investing a large percentage of your assets in low-cost index funds, and then using the rest to invest in individual stocks. A healthy percentage is 10 to 20 percent that you personally invest in stocks. With this plan, you still get to enjoy stock investing and keeping score but without taking big risks.
- However … there are some good reasons for stocks to be a relatively large percentage of your overall investable assets. For example, you could have inherited a large position in a stock that’s subject to large capital gains taxes. You may choose to diversify, but if it’s a solid company, it might be good to maintain the position to avoid taxes.
Other investors seek dividend income, so they own stock in more conservative companies that have a record of paying good, and rising, dividends over time. Still other investors choose to own a conservative stock portfolio of great companies they trust for the future. They invest in companies that they believe will endure recessions over the next 20, 30, or even 50 years. Over 20 years, their portfolio might return 6.5 percent, compared to the average S&P 500 returns of 8.5 percent, but they sleep well at night knowing the companies they own stock in are on a solid footing. Tilly can appreciate this thought process, so long as their portfolios have good diversification and are savvy with regards to analyzing companies.
- Over a long period of time, say 20 or 30 years, your chances of beating the returns of the overall stock market are extremely low. Consider this: In the U.S., thousands of mutual funds are staffed with MBAs from some of the finest business schools in the country, and their sole jobs are picking stocks. Those funds rarely beat the S&P 500 Index over long periods of time. Sure, each fund may have a few years of glory, but it’s rare they can beat the major indexes containing huge baskets of stocks over 10 or 20 years. Of course, they have restraints you don’t have as an individual stock-picker, but do you truly believe you have better information or greater analysis skills than they do? It’s important to acknowledge your capabilities and limitations.
- Play the stock market outside of your retirement plans (e.g., 401(k), IRA, etc). Tilly mostly recommends that, unless you’re a professional investor, you should maintain solid diversification in your retirement plans, which is best accomplished by owning low-cost index mutual funds and exchange traded funds (ETFs). Leave stocks for your taxable brokerage accounts.
- If you don’t understand the fundamentals of stock valuation, it’s probably best to remain on the sideline. A few years ago, I wrote two blogs about how to value a stock. In Part 1, I discussed the main financial metrics for valuing a stock. In Part 2, I discussed the relationship between those financial metrics and the stock price. If you aren’t comfortable in terms of understanding stock valuation, it’s probably best to stick to owning mutual funds and ETFs. Otherwise, you can never be sure of how much risk you’re taking on when purchasing a stock.
I hope this helps you weigh if stock market investing is for you. Please reach out to Tilly if you have any questions.