As individual investing continues to gain popularity among everyday Americans, many are drawn to the success stories of friends who benefitted from buying stocks in tech giants like Nvidia, Amazon, or Apple at low prices. Such tales can be inspiring but raise important questions about how much can be safely invested in individual stocks.
Financial planners typically recommend that retirement savers prioritize shares of index funds, which tend to follow the wider market trends and offer a more stable investment alternative. The volatility of individual stocks presents greater risks, particularly for those who may not have extensive investing experience. However, with a recent survey from the BlackRock Foundation and Commonwealth revealing that 54% of low- to moderate-income Americans actively invest in capital markets, it’s clear that many individuals are eager to dive into the stock-picking game.
Investors often turn to social media influencers sharing their stock picks, along with reputable investing sites like The Motley Fool and Morningstar, in hopes of discovering the next big opportunity. As Zachary Rayfield from Vanguard noted, there’s a compelling element of excitement associated with trading individual stocks.
For those considering investing in individual stocks, experts recommend starting cautiously. Apparel investment in index or target-date funds is advised as a foundation due to their relative stability. It is suggested that inexperienced investors allocate only a small percentage—approximately 5%—of their portfolio to individual stocks. This strategy is especially critical for those using retirement funds, ensuring that the primary investments remain stable.
Concentration risk is another consideration for individual stock investments. Experts stress that no single stock should make up more than 5% to 10% of an investor’s total portfolio. This precaution safeguards against severe portfolio declines should a chosen stock falter. Caleb Silver, editor-in-chief at Investopedia, highlighted that many investors inadvertently end up overconcentrated in one stock due to its soaring value, such as Nvidia shares, which could lead to significant losses.
Furthermore, diversification remains a fundamental principle in investing. Investors are encouraged to build a portfolio consisting of various asset classes, including stocks from different sectors, company sizes, and even bonds. For those putting a small portion of their investments in individual stocks, a focused approach—selecting 5 to 10 stocks with strong track records—may offer potential rewards. Alternatively, some experts advocate for a broader diversification, suggesting a portfolio with at least 25 different stocks.
While engaging in active stock selection may provide thrilling experiences, there’s a cautionary tale in the reality that many active fund managers fail to outperform the market. Rayfield underscores that amateur investors stepping into the role of active manager may face similar difficulties. Additionally, selling underperforming stocks at a loss to offset gains—a tactic known as tax-loss harvesting—can create a skewed perception of overall performance.
As Brokamp from The Motley Fool points out, an individual’s portfolio will likely contain a mix of winners and losers, with a select few high-performing stocks driving the overall returns. Thus, potential investors should prepare for the fluctuating nature of individual stocks, understanding that a diversified, well-structured approach remains the best strategy for long-term financial health.
