What Are the Pros and Cons of Single Stocks in Your Portfolio?
Stocks, mutual funds, or exchange traded funds (ETFs):What is the best option when you want to invest in the stock market?Is it worth the time and risk to have single stocks in your portfolio, or should you instead select mutual funds or ETFs, which give you exposure to sectors you likewithout the risk of placing all your eggs in one basket?
While there are many factors to consider here—like the amount of time you have to dedicate to investing or your tax planning needs—there is one other theory in investing that comes into play. Modern portfolio theoryfocuses on maximizing your return without adding too much additional risk.
To summarize, modern portfolio theory says that there is a point at which you can combine different investments that minimize risk for the entire portfolio while getting maximum returns.
This occurs because when you combine assets, you are diversifying your unsystematic risk, or the risk related to one specific stock.You get this diversification because you buy stocks that have a low correlation to each other so that when one stock is up, others are down.
Key Takeaways
- Many factors go into considering the efficacy of holding single stocks in your portfolio—like the amount of time you have to dedicate to investing, your tax planning needs, and your experience as an investor.
- Pros for single stocks in portfolios include reduced fees, understanding the taxes owed and paid, and an ability to better know the companies you own.
- Cons include more difficulty diversifying your portfolio, a potential need for more time invested in your portfolio, and a greater responsibility to avoid emotional buying and selling as the market fluctuates.
Understanding the Pros and Cons of Single Stocks in Your Portfolio
When trying to get as much return as you can for the least amount of risk, your number one concern should be diversification. While having low fees and managing your own tax situation is good, it is better to have adequate diversification in your portfolio. If you don't have the funds to make this happen, an ETF or mutual fund is probably better for you—at least until you build up a solid base of stocks.
Pros of Holding Single Stocks
- When buying individual stocks, you see reduced fees. You no longer have to pay the fund company an annual management fee for investing your assets. Instead, you pay a fee when you buy the stock and one when you sell it. The rest of the time there are no additional costs. The longer you hold the stock, the lower your cost of ownership is. Since fees have a big impact on your return, this alone is a good reason to own individual stocks. (See also: Cost of Newly-Issued Stock.)
- You understand what you own when you pick out the stock. You have complete control of what you are invested in, and when you make that investment.
- It is easier to manage the taxes on your individual stocks. You are in charge of when you sell, so you control the timing of taking your gains or losses. When you invest in a mutual fund, the fund determines when to take the gains or losses and you are assigned your portion of gains. This is true even if you just bought into the fund at the end of the year.
Cons of Holding Single Stocks
- It is harder to achieve diversification. Depending on what study you are looking at, you must own between 20 and 100 stocks to achieve adequate diversification. Going back to portfolio theory, this means more risk with individual stocks unless you own quite a few stocks.
- Achieving this diversification is harder the less money you have. Especially when you start investing, you are subjecting yourself to more risk due to the lack of diversity. (See also: Investing for Safety and Income: Introduction.)
- It requires more time from you to monitor your portfolio. You need to ensure that the companies you've invested in aren'thaving business problems that could wipe out your bet. You also need to monitor industry and economic trends. You're your own portfolio manager, so you must spend the time to ensure you're not holding a bad position.
- You must keep your emotions in check. It becomes easier to sell a loser or buy a hot-tip stock because you can instantly log in and make the trade in minutes. This can increase your fees for trading and can also lock in losses that would have been avoidable by holding something a bitlonger.
FAQs
There is no set definition for what makes a concentrated position. When an investment in a single stock represents more than 5% of a portfolio, T. Rowe Price advisors consider it to be worth addressing. Once a holding exceeds 10%, however, it represents a greater risk that requires more immediate planning.
Why not to invest in single stocks? ›
Financial pros like Benz urge investors to build broadly diversified portfolios for a reason: While the overall historical trajectory of the stock market has trended upward, any individual stock has a chance to decline sharply in price and destroy your portfolio's returns.
What is a good number of stocks to have in your portfolio? ›
Most studies use the fully diversified portfolio as a benchmark and then derive that a portfolio of 20-30 stocks achieves a 'similar' risk profile as the target portfolio.
Is it better to invest in single stocks or index funds? ›
Investing most or all your money in individual stocks is risky and can lead to losing your investment capital. Investing exclusively in index funds is risk averse and offers much less in the way of returns. Ideally, you want to keep most of your investment dollars in safer investments such as index funds.
What are the disadvantages of single stocks? ›
Cons of Holding Single Stocks
- It is harder to achieve diversification. ...
- Achieving this diversification is harder the less money you have. ...
- It requires more time from you to monitor your portfolio. ...
- You must keep your emotions in check.
If you want the control and involvement of choosing which stocks to own, individual stocks may fit your needs. However, if you don't want to be as involved in the investing process, individual stocks may not be appropriate for you.
Is it OK to have 100% stocks in my portfolio? ›
The research by three U.S. finance professors led by University of Arizona professor Scott Cederberg comes to the surprising conclusion that a portfolio holding 100% stocks and no bonds is best, even for people already in retirement.
How much do I need to invest to make $1000 a month? ›
A stock portfolio focused on dividends can generate $1,000 per month or more in perpetual passive income, Mircea Iosif wrote on Medium. “For example, at a 4% dividend yield, you would need a portfolio worth $300,000.
Is it realistic to have 100% of your portfolio in stocks? ›
There's no universal answer as to whether someone should invest entirely in stocks. Bonds can help take the anxiety out of wild price swings. However, a 100% stock portfolio can be a fit for younger investors far from retirement.
What are 2 cons to investing in index funds? ›
Disadvantages of Index Investing
- Lack of downside protection: There is no floor to losses.
- No choice in the index fund's composition: Cannot add or remove any holdings.
- Can't beat the market: Can only achieve market returns (generally)
A stock gives you one share of ownership in a single company. An index fund is a portfolio of assets which generally includes shares in many companies, as well as bonds and other assets. This portfolio is designed to track entire sections of the market, rising and falling as those segments do.
Is it OK to only invest in index funds? ›
Investing legend Warren Buffett has said that the average investor need only invest in a broad stock market index to be properly diversified. However, you can easily customize your fund mix if you want additional exposure to specific markets in your portfolio.
Is 10% in one stock too much? ›
Once a holding exceeds 10%, however, it represents a greater risk that merits more immediate planning. “The risk of a concentrated position can be magnified by additional career risk in the case of company stock,” says Marty Allenbaugh, CFP®, CPWA®, a senior advisor with the T.
How many shares of a single stock should I own? ›
What is a good number of shares to buy? The number of shares you should buy depends on the price of the stock and how much money you are willing to invest. For example, if a stock is worth $10 and you have a $10,000 portfolio, a good number of shares would be between 20 to 100 depending on your risk tolerance.
How much is too much in a single stock? ›
Generally, if more than 10% of your entire portfolio is in individual stocks most would consider that too much.
What is the ideal stock portfolio mix? ›
Many financial advisors recommend a 60/40 asset allocation between stocks and fixed income to take advantage of growth while keeping up your defenses.
