qandaQ:Do you always advise against owning individual stocks?

Q: In a MarketWatch article, you wrote, “I don’t recommend owning individual stocks,” but didn’t give any reasons. I’d like to know if your advice is 100% ironclad to all persons or if, for example, you had multi-millionaire clients for whom you recommended individual stocks…or did you turn away that business?  

A: When I was an advisor I never recommendedindividual stocks, regardless how large the account. I have a fairly large account myself and, with the exception of some ETFs, I don’t own any individualstocks. In previous articles I’ve often noted that my beliefs about the best steps to successful investingcome from what I have learned from the academic community. Having been around the investment community for over 50 years, I know that almost every investor thinks their individual stock picks are better than the market. I have absolutely no way of knowing if that will be true or not. 

The academics teach us that the expected rate of return of any individual large-cap growth stock is the average of all large-cap growth stocks. Of course some will do better and some worse, but the expected rate of return for all shareholders must be the average. That doesn’t change the fact that if investors own a stock, they see it worth more than investors who don’t own that stock. In fact, according to studies, it goes beyond what you like. It seems it also depends on your nationality. In surveys, Germans think they make 2% more a year than U.S. investors. Not surprisingly, U.S. investors who took the same survey believed they make 2% better returns than German investors. For a great book on how investors think, please read Your Money and Your Brain by Jason Zweig. It’s one of four books I try to get all investors to read. 

So, if the expected rate of return for one stock is the same as 1000, the smart thing would be to own all 1000, as the risk of owning just one is huge. The challenge is to access the best asset classes, and access them as efficiently as possible. I think the more mechanical we are in our investment decisions, the better we are likely to do. Automatically dollar-cost-averaging from your paycheck: mechanical. Using index funds: mechanical. Rebalancing is also likely best done mechanically. Taking money out of investments in retirement can be done mechanically.  

Owning an individual stock becomes a very emotional experience for most investors.  I think eliminating any emotional attachments improves your probability for success.