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For relatively speaking young, middle / lower middle-class investors, what percentage of our investments should be individual stocks?

I've done an excellent job keeping my credit outstanding and my bank account growing. Part of that was job insecurity. Now I'm in a better working environment so want to do more with my money then having it just sit in Money Market accounts.

I do have a 401(k) with match. And I've got a very, very small mutual fund in emerging markets that my mom got me a few years back.

In my 401(k) I elected to put 75% into a no-cost S&P500 Index, and 25% into a low-cost small cap fund. I didn't have many funds to choose from.

Now I'm weighing options to further my investments particularly Mutual Funds or Individual Stocks. I did read What percentage of my portfolio should be in individual stocks? but think a similar question for younger investors is in order. Us young capitalists don't have $320,000. Where for example some say 10% is an acceptable loss in that question [based on the OP], and I too would be acceptable with a 10% loss - the difference is for individual stocks there's a lot more buying power with $32,000 then there is for say $2,000-$4,000.

On the one hand I often hear young investors should be more aggressive. On the other hand I'd lose far more to fees and taxes going after individual stocks then someone with more to lay down.

So the question is when should a young investor go for "aggressive" mutual funds, and when they should they delve into individual stocks?

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As a younger investor, you can be more risky. You should invest in stocks over bonds since the reward can be much higher. Watch out for high fees, as you mention. High-fee managed funds aren't worth it because they have to outperform cheap ETFs by the amount of their fees and this rarely happens. Vanguard funds are generally good to stick to since they have low expense ratios. Also, once you get $10k in a many Vanguard funds you can convert them to "Admiral shares" which have even lower expense ratios. –  Aaron Brager Jun 24 at 16:58
    
Stay away from individual stocks, unless you know the company very well. (I mostly have funds, but hold a lot of AAPL, because I used to work there and understand the company's business.) –  Aaron Brager Jun 24 at 16:59
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...@AaronBrager this sounds like useful information. Why not leave it as Answer instead of a long comment? –  Ender Jun 24 at 16:59

4 Answers 4

up vote 9 down vote accepted

The short answer: zero.

dg99's answer gives some good reasons why. You will basically never be able to achieve diversification with individual stocks that is anywhere close to what you can get with mutual funds. Owning individual stocks exposes you to much greater risk in that random one-off events that happen to affect one of the companies you own can have a disproportionate effect on your assets. (For instance, some sort of scandal involving a particular company can cause its stock to tank.)

There are only two reasons I can see to invest in individual stocks:

a. You have some unique opportunity to acquire stock that other people might not be able to get (or get at that price). This can be the case if you work for a privately-held company that allows you to buy stock (or options), or allows you to participate in its IPO. Even then, you should not go too crazy, since having too much stock in the company you work for can double your pain if the company falls on hard times (you may lose your job and your investment).

b. For fun. If you like tracking stocks and trying to beat the market, you may want to test your skills at this by using a small proportion of your investable cash (no more than 10%). In this case you're not so much hoping to increase your returns as to just enjoy investing more. This can also have a psychological benefit in that it allows you to "blow off steam" and indulge your desire to make decisions, while allowing your passive investments (index funds) to shoulder the load of actually gaining value.

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You should only invest in individual stocks if you truly understand the company's business model and follow its financial reports closely. Even then, individual stocks should represent only the tiniest, most "adventurous" part of your portfolio, as they are a huge risk.

A basic investing principle is diversification. If you invest in a variety of financial instruments, then:

(a) when some components of your portfolio are doing poorly, others will be doing well. Even in the case of significant economic downturns, when it seems like everything is doing poorly, there will be some investment sectors that are doing relatively better (such as bonds, physical real estate, precious metals).

(b) over time, some components of your portfolio will gain more money than others, so every 6 or 12 months you can "rebalance" such that all components once again have the same % of money invested in them as when you began. You can do this either by selling off some of your well-performing assets to purchase more of your poorly-performing assets or (if you don't want to incur a taxable event) by introducing additional money from outside your portfolio. This essentially forces you to "buy (relatively) low, sell (relatively) high".

Now, if you accept the above argument for diversification, then you should recognize that owning a handful (or even several handfuls) of individual stocks will not help you achieve diversification. Even if you buy one stock in the energy sector, one in consumer discretionary, one in financials, etc., then you're still massively exposed to the day-to-day fates of those individual companies. And if you invest solely in the US stock market, then when the US has a decline, your whole portfolio will decline. And if you don't buy any bonds, then again when the world has a downturn, your portfolio will decline. And so on ...

That's why index mutual funds are so helpful. Someone else has already gone to the trouble of grouping together all the stocks or bonds of a certain "type" (small-cap/large-cap, domestic/foreign, value/growth) so all you have to do is pick the types you want until you feel you have the diversity you need. No more worrying about whether you've picked the "right" company to represent a particular sector. The fewer knobs there are to turn in your portfolio, the less chance there is for mistakes!

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The lower the risk the lower the return!x You should be looking at and learning about risk management to maximize your returns. Rebalancing, especially with individual stocks is the dumbest thing you can do, if you bought Apple at $100 and sold it at $200 you would have missed it going to $700. If you bought another stock at $100 and went to buy more when it dropped to $80, what do you do when it continues dropping to $50 or less? –  Victor Jun 24 at 21:49
    
I believe my answer plainly states that I do not recommend trading in individual stocks, so the scenario you suggest is irrelevent. As to the first two sentences of your comment, I (and presumably the OP) am not looking for a high-risk strategy. I am content to earn exactly what the sum total of the world's markets earns. Trying to do better than the market at large is both a fool's errand (as evidenced by the 90% of managed funds that do not beat the market) and NOT appropriate for someone in the "lower-middle class". –  dg99 Jun 24 at 22:31
    
Managed funds don't beat the markets because they rebalance their portfolios. Your answer is based on your own opinions and may or may not be truely helpful to the OP as you are not their financial advisor. The only advice I would give anyone is to not invest in anything unless you educate yourself first in that area. –  Victor Jun 24 at 23:20

I would not advise any stock-picking or other active management (even using mutual funds that are actively managed). There is a large body of knowledge that needs learning before you even attempt that.

Stay passive with index funds (either ETFs or (even better) low-cost passive mutual funds (because these prevent you from buying/selling).

But I have not problem saying you can invest 100% in equity as long as your stomach can handle the price swings. If you freek out after a 25% drop that does not recover within a year, so you sell at the market bottom, then you are better off staying with a lot less risk. It is personal.

There are a lot of valid reasons for young people to accept more risk - and equally valid reason why not. See list at http://www.retailinvestor.org/saving.html#norisk

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I don't believe the decision is decided by age or wealth. You only stock pick when a) you enjoy the process because it takes time and if you consider it 'work' then the cost will probably not be offset by higher returns. b) you must have the time to spend trading, monitoring, choosing, etc. c) you must have the skills/experience to 'bring something to the table' that you think gives you an edge over everyone else. If you don't then you will be the patsy that others make a profit off.

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