This post explains why I don't pick individual stocks.
Many years ago when I first heard about the stock market I had two thoughts. Firstly, what an easy way to make money, and secondly that I would be really good at picking the right stocks.
A little part of me looked at it like sports betting, and I as I used to dabble in a bit of this at university, I had plenty of experience. It was mostly football I would bet on and always small amounts, with normally huge return odds. I used to bet on the ‘safe’ teams as well but this had less of an allure. As you might have guessed over my betting career I did not end up on top, but I did enjoy the whole experience if I am an honest as it made Saturdays in the pub a bit more fun.
Back to picking stocks though. I would hear of these people who had made millions investing into companies just before they blew up. It seemed so obvious. Of course, this random small oil refinery in Kazakhstan would be hugely profitable, of course this tiny tech start-up selling an obscure product whose office was in their parent’s garage would become the hottest company in Silicon Valley.
I genuinely thought I would be able to know which companies were on the up, and that when I had some spare cash, I would step into the world of buying and selling stocks, and make lots of money.
The time finally came where I had some spare cash, about £500 that I was happy to invest into a company. I looked at these big fish investors who had made their millions from investing in these new up-and-coming companies. There were a few things that were apparent, it was new to me but may be obvious to you.
1/ The likelihood of getting a return was incredibly low
2/ The pay-out had the potential to be incredibly high
Simply put - it was risky.
Let’s look at this compared to my football betting I was doing in Uni – a lot of similarities. I knew football fairly well, so my educated guess of picking an accumulator of 5 games was almost always was never successful. I was also only betting £1-5 on these ridiculous accumulators, and had about 4-5 on the go for any weekend of football. So I translated this over to my £500 I would need to pick 4-5 companies and put £100 on each. But if I had the same success rate as my football I could pretty much kiss that money good bye. I was content with losing the £10-20 on a weekends betting every so often with the pay-out for £10,000, but to lose my £500 was too much risk for me.
Time for Plan B. Go for the safe bet. Go for Man City at home against the bottom of the league team. Pick Coca-Cola stock and enjoy the safer option. Looking at past data from 2011-2021 it had an average return of around 5%. So over 10 years this would give me a return including initial investment of £745.42.
£245.42 “profit” for Coca-Cola to do well – I am ignoring any dividend payments here so I don’t complicate things further.
But what if Coca-Cola doesn’t do well? What happens if they go bust, merge, or the entire planet really goes on a health kick? I will then have a period perhaps with no return – or a loss!
My cold feet and worry were kicking in again.
This £245 isn’t the particular amount I could party hard with for the amount of concern I would have constantly watching the stock price of Coca-Cola.
So now what? I felt dejected and my grand-plan of using stocks to make my money was over before it began. I decided I just needed more disposable income that it meant less to me so I would be happier to throw it to riskier options.
This was the plan up until last year when I started on my FI journey and was introduced to Index Funds. For those of you who don’t know index funds are a collection of stocks aimed at tracking an index, such as the S&P 500 or the Nasdaq 100. When you put money in an index fund, that cash is then used to invest in all the companies that make up the particular index, which gives you a more diverse portfolio than if you were buying individual stocks.
So I would have access to Coca-Cola, plus a load of other massive companies such as Facebook, Google, Tesla etc.
This sounded pretty decent, but did it reduce the risk down compared to buying single stocks, and if I was good at picking single stocks, could I end up making more?
Enter ‘The Four Pillars of Investing’ book recommended by Mr Money Moustache. This was incredible heavy book which was way too deep for me at my time of understanding, but it meant I had to learn quick!
In the book it explains how even the best stock brokers in the world cannot beat the index funds. You get very rare individuals who can, but as a percent of those trying this would be in the 0.001% category – or perhaps even rarer!
In 2008 Warren Buffet made a bet with active manage hedge funds that they could not beat the S+P 500 over a 10 year period – and guess what, he was right.
They conceded defeat 2 years early and over that period the index fund had a cumulative of 85.4% and the active fund only had 22%.
Warren Buffett who is one of the 0.001% of people who can make a profit buying and selling individual stocks famously said this:
My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors – whether pension funds, institutions or individuals – who employ high-fee managers.
Why oh why would one of the world leaders who has made a lot of money picking individual stocks, tell people to go with Index Funds?
Because he knows the maths, he knows the history, and he knows picking individual stocks is incredibly hard.
My advice – don’t get caught up in the hype, set it and forget, and follow basic maths!
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