What do we do when we have an itch? We scratch it. If we scratch an itch too much, we hurt ourselves. For the majority of people, investing in individual stocks is an itch. At many points in our lives, we want to scratch the itch and invest in individual stocks. Few people become household names when they scratch this itch, but most people lose money.
We call this phenomenon the Warren Buffett itch. Everyone wants to give it a shot. Everyone wants to win in the stock market and be the next Warren Buffett. Hey, we gave it a shot too and we scratched that itch. At the time, we lost 30% of the money we invested. A few years later, we gave it another shot. Guess what happened next?
We still lost money, but this time, we lost much less (thankfully). We learned a bunch about the stock market, how it operated, how to read financial documents, and how we cannot time the market. It is a great learning experience. We also understood for long-term financial goals such as investing for retirement, individual stocks will only hurt us.
The itch continues to come back periodically and every time it comes back we should scratch it in moderation. Take risks to learn and have fun, but not at the cost of your retirement. For us, we see moderation as less than 5% of your investments. If you have less than 5% of your investments in individual stocks, that’s okay. The rest of your 95% should be in total market mutual funds. And for the select few who don’t have the itch, they should stick with 100% in total market mutual funds.
We just have to remember whether we win or lose, we must keep our individual stock investments at less than 5%. Moderation is important because we all know it is nearly impossible to predict stock prices. We all think that when a company performs well, its stock prices must goes up. But did you know when a company performs well, its stock price can also drop¹? The issue with investing in individual stocks is that there is a high chance you will lose money. For people who are planning to invest only in individual stocks until retirement, they are taking a large risk. These people would have to make the right choices between buy, hold, or sell for 40+ years in a row. This is a near impossible feat and it is difficult to make such predictions. Even the experts on Wall Street can lose billions. The graph below shows how many U.S. companies, including many investment firms, went bankrupt during and after the 2008 recession².
You don’t need to worry about picking the wrong stock if you are responsible in your investment choices. We all get an itch and it is good to scratch it once in a while. Always remember:
Less than 5% invested in individual stocks and the remainder should be invested in total market mutual funds
Have fun with your investments and as always, we are happy to chat in the comments!
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