Should You Pick Your Own Stocks?

When you picture investing, you might think of buying and selling individual stocks, trying to pick the next big winner. And it’s easy to see why people tend to think of investing this way. Financial media always seems to be talking about which individual stocks are doing well (and which aren’t). Conversations about stock picking have become even more commonplace due to social media and online forums.

You might be surprised to learn that doing your own stock picking is not the primary strategy experts recommend for most investors. Sure, it has its advantages. But it also brings with it some major risks that mean it probably shouldn’t be the approach you take with most of your investment portfolio.

What Is Stock Picking?

Stock picking is the process of choosing individual stocks to invest in rather than buying shares of diversified funds. Stock picking gives you control over your investments in a way that fund investing may not, but also requires a deep understanding of the stock market—and even then, it doesn’t always result in positive returns.

Fundamental analysis is a process investors and analysts use to gauge the potential growth of a company using internal metrics such as earnings per share, price-to-earnings ratio, dividend yield, and more. Technical analysis, on the other hand, uses a company’s historical returns to make an educated guess about future returns. Fundamental analysis is more prospective, while technical analysis is retrospective.

Pros and Cons of Stock Picking

Pros Explained

• Lower investing fees: Many brokers now offer commission-free trading, meaning you don’t pay fees when you buy or sell stocks. Additionally, you aren’t subject to the annual expense ratios you’d find with a mutual fund or ETF.
• More control over your portfolio: When you pick individual stocks, you have ultimate control over what is (and is not) in your portfolio, compared with holdings funds that may have hundreds or even thousands of assets.
• More tax control: Mutual funds have some tax disadvantages, and you may end up paying taxes on your investment even when you haven’t sold. But with individual stocks, you have control over when you pay capital gains taxes.
• Create a fixed income: Investors who want to create a fixed income can use stock picking to create a portfolio of dividend-paying stocks. Those dividends can be reinvested or used as a form of regular income.

Cons Explained 

• Lack of diversification: Diversification is the process of spreading your money across many different assets to reduce risk. It’s a key principle of investing, and difficult to achieve by investing in individual stocks.
• Higher investment risk: All investing requires some level of risk. But investing in individual stocks puts you at even greater risk because if the company you’ve invested in underperforms or goes out of business, it affects your entire holding.
• Requires time and knowledge: There’s a reason why picking stocks is some people’s full-time job. It requires significant time and knowledge to do the fundamental and technical analyses necessary to pick individual stocks for solid returns.
• Lower historical returns: In the debate between active versus passive investing, data has consistently sided with passive investing. Active investors—even professional ones—tend to underperform the stock market overall.

Picking Stocks vs. Investing in Funds

Rather than picking individual stocks, most experts recommend a more diversified approach achieved by investing in mutual funds and ETFs. With these funds, you gain exposure to hundreds—or even thousands—of assets, rather than a few individual companies.

“It’s less exciting, but investing in ‘boring’ investments like ETFs generally results in bigger gains than daily stock picking,” Corbin Blackwell, a senior financial planner at Betterment, told The Balance in an email interview. “This is because mutual funds and ETFs are inherently diverse.”

While investing in funds may not sound electrifying, historical data shows that it’s the most successful approach. For example, Morningstar publishes a semiannual report that measures the performance of active funds against their passive counterparts. In the short term, the investment research firm has found, the results don’t seem that negative for stock picking. In 2020, for example, just shy of half of active fund managers outperformed their passive peers. However, the numbers lean far more heavily toward passive investing when you look at a longer period.

The most recent Morningstar report found that over the 10-year period preceding June 2021, only 25% of actively managed funds beat their passive counterparts.

Of course, investing in funds isn’t entirely without downsides. Mutual funds and ETFs have annual fees, known as expense ratios. The good news is that in line with trading commissions falling significantly in recent years, expense ratios also have declined. According to Morningstar, the asset-weighted average expense ratio for passively managed funds (also known as index funds) was just 0.12% in 2020. Some brokers have even begun offering funds with 0% expense ratios.

Should You Pick Your Own Stocks?

Based on the historical returns of active investors versus the market overall, it’s easy to see why most experts recommend investors turn to diversified funds instead of individual stocks. Even Warren Buffett, one of the most prominent and successful investors, has famously said that most investors are better off investing in an S&P 500 index fund than picking individual stocks.

“At the end of the day, it is just much harder to construct a well-diversified portfolio using single stocks, which is why I typically recommend steering away from individual stock picking,” Blackwell said.

Blackwell, like many other investing experts, recommends a well-diversified portfolio of mutual funds or ETFs, which spread out your investment risk, save time, and ultimately result in better returns most of the time.

Frequently Asked Questions (FAQs)