I have been covering personal finance for over four years, but it wasn’t until I officially became a Certified Financial Planner in October that my family started seeking investment advice.
Two parents in as many weeks texted me asking for specific actions and if they would be a good investment. I’m flattered that they ask for my advice (especially since I’m younger than them), but investing can be a tricky subject.
Telling someone that they should or shouldn’t buy a stock without knowing what the rest of their financial situation looks like is risky. I’m inclined to ask if they have an emergency fund or high interest rate debt outstanding, as this is a good indicator of whether someone is willing to invest in general.
Here is an extended version of what I told my family members who texted me, and what I would say to anyone who asks me if they should invest in an individual stock.
Don’t invest money you’re not ready to lose
This is rule # 1 when it comes to investing, in my book. If you can’t afford to lose your investment, now is probably not the time to buy the stock.
The average stock return over the past decade is around 9%, before taxes. But stocks rise and fall throughout the day, and the trajectory of an individual firm can be much more volatile than an entire index or sector.
The shorter your time horizon – or the length of time you plan to stay invested – the riskier it becomes. The longer your time horizon, the more time you have to wade through the ups and downs and end up with an average return.
Chances are good that you aren’t wasting every penny you invest in a stock – especially if it’s a high-value company – but on the assumption that you can is good practice.
Think about index funds
Most people invest in the stock market to make money. It’s risky, but the prospect of turning your money into Following money is irresistible to some. Fortunately, there are some easy ways to lower your risk, especially if you have several years, or even decades, to grow your investments.
Index funds are a type of low-cost mutual fund that diversifies your money across a wide selection of stocks or bonds. Rather than picking and buying individual stocks, an investor owns a small portion of each company or asset in the fund, which tracks an index, like the S&P 500 (the 500 largest public companies).
I recently hosted a live event where financial advisor Kevin Matthews shared one of the best analogies I’ve heard on this topic. To paraphrase, he said investing in a stock is like buying a single basketball team. Investing in a mutual fund is like owning the entire league; you don’t have to worry about whether a player gets injured or a team is misbehaving because your losses are spread out. Someone will always win.
That means you don’t have to choose the best stock anymore, or at least one that won’t lose, he said, and there is some safety in that.
Think about your strategy
If you are sure you want to buy the shares of a sole proprietorship, understand Why you do it. Are you trying to make a quick comeback? Are you taking a hot stock tip? Do you actually use the company’s products or services and believe in its mission? Are you building a diversified portfolio?
Your reason for investing in the first place is really what should determine what type of investment you choose, whether it’s an individual stock, a mutual fund, or whatever.
There is nothing wrong with buying individual stocks. Many investors are successful and successful in the long term, especially those who use a buy and hold strategy.
But for the vast majority of investors, successfully buying and trading individual stocks takes a tremendous amount of time, skill and restraint. Even as a financial planner, I don’t mind timing the market.
Sallie Krawcheck, a former Wall Street executive and now CEO of Ellevest, put it bluntly at the start of the pandemic: and making money is a crazy mission. “
Tanza Loudenback, CFPÂ®, is the Personal Finance Correspondent at Business Insider. She writes most frequently on savings, retirement planning, taxes, debt management, and wealth building strategies. Got a question about money for Tanza? Fill out this anonymous form.