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Should You Buy Individual Stocks or Stick to Mutual Funds?

Here are some rules if you're feeling lucky

silver dice cubes with the words SELL BUY on top of stock chart background

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En español | I own over 10,000 individual stocks with just one total U.S. stock index fund and one total international stock index fund. That's the core of my stock portfolio, and both have had a good year so far.

As happy as I am with my funds, they still don't exercise the piece of my brain that wants to have a little fun picking individual stocks. I'm of the opinion that it's fine to have a little fun with investing and it's OK to pick some stocks, as long as you follow some rules.

Thrills and chills

It would certainly be fun to imagine owning only the top 10 performers in the Standard and Poor's 500 stock index this year through Dec. 1, 2020. Here they are, according to S&P Capital IQ.

 

S&P 500 Index 10 Top Performers 1/1/2000 - 12/1/2020

Company name — (Ticker) — % change

Etsy, Inc. (NasdaqGS:ETSY) 249.1 

NVIDIA Corporation (NasdaqGS:NVDA) 127.9 

L Brands, Inc. (NYSE:LB) 117.3 

Advanced Micro Devices, Inc. — (NasdaqGS:AMD) 102.0 

PayPal Holdings, Inc. (NasdaqGS:PYPL) 100.2 

FedEx Corporation (NYSE:FDX )92.7 

ServiceNow, Inc. (NYSE:NOW) 91.1 

Albemarle Corporation (NYSE:ALB) 88.7 

West Pharmaceutical Services, Inc. (NYSE:WST)81.5 

Freeport-McMoRan Inc. (NYSE:FCX) 80.9 

(data source: S&P Capital IQ Equity Screening Report)

Even better would be to own a few of the top performers not in the S&P 500 — such as Tesla (TSLA), up 598.9 percent, and vaccine maker Moderna (MRNA), up 620.9 percent. Tesla, by the way, is the sixth-most-valuable U.S. stock. The company's stock will be admitted to the S&P 500 on Dec. 21. Of course, at the start of the year, Corona was associated more with a beer than a pandemic, and Zoom was something you did with your camera.

In addition to much else, 2020 was certainly the poster year for unpredictability. And unpredictability can make picking stocks pretty thrilling — which, admittedly, is a feeling to which I'm not immune. Beneath my dull exterior of an index investor beats the heart of the Gambler. Even I get the occasional urge to buy that risky stock and get those spectacular returns, and sometimes I just can't resist acting on my thrill-seeking urges.

That's why I carve out a small piece of my portfolio for, perhaps, the only fun I have in investing. I call it my gambling portfolio.

My rules

Now, everybody should have a personal system to outsmart the market. My own belief is that buying one of these stocks after a spectacular gain is following the herd and doesn't end well. Though I don't tell people what they should buy, I do give them rules.

My system is buying stocks that have fallen from grace and that I think have about a 50-50 chance of going bankrupt.

Companies shunned by Wall Street can often end up performing not as badly as expected, and the stock price rises if the company exceeds the Street's low expectations. It's very risky, I'll admit, but I think it's better than being part of the herd following TV gurus or buying a stock after a spectacular return.

I'm always happy to talk about my winners, such as Priceline (now Booking), IBM and, more recently, GE (so far, anyway), though I conveniently block out my purchases of United Airlines, Delta Airlines, Eastman Kodak and others that didn't make it or are looking rather bleak.

How has it worked? In my emotional mind, the Gambler convinces me that I have kicked market booty with the returns I've received. I don't really care what my logical mind says because, you know, this is supposed to be fun. I could easily go back and evaluate my return versus the market, but why do that? I prefer to keep my parade unrained on.


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What does this mean to the gambler in you?

My emotional brain is in the driver's seat for my gambling portfolio. This is invested in a strategy that I think will win by picking ultra-risky individual stocks that Wall Street doesn't want.

I call my total portfolio a core-and-casino approach. The core part is in the logical, dull, own-the-whole-market index funds. The casino part consists of the risky-business stocks I pick from the emotional side of my brain, or the Gambler approach. Viva Las Vegas.

Rules for My Gambling Portfolio

  1. Gambling is gambling; whether it's investing or blackjack, I only bet what I can afford to lose — typically, less than 5 percent of my portfolio.
  2. When I'm looking for that risky stock to buy, I go so far off the beaten path that I need a machete. Look for me on the wrong side of the Wall Street tracks.
  3. The buy signals that catch my gambler's eye include purchasing stocks:
    • After large price declines.
    • Priced below $5, which forces many institutional investors to dump.
    • Media report that money managers are being fired for holding.
    • Linked to accounting scandals.
    • Connected to insider trading allegations.
    • In a company that media gurus are saying is dead.
  4. Make lemonade out of those stock lemons that went belly-up by harvesting the tax losses. You can use your capital losses to offset capital gains elsewhere, and if you have money left over after that, you can deduct up to $3,000 in losses on your federal income taxes. If you still have losses, you're gambling too much — but you can carry those unused losses to the next tax year.
  5. Keep perspective on my wins and losses and the territory they go with. It's my own version of “What happens in Vegas, stays in Vegas” (or ought to).
  6. Never confuse luck with brilliance.

Mark Twain once remarked that the rules that got him to age 70 would kill anyone else. These are the rules that work for me. They may be too risky for you, or even not risky enough. But the rule you should always remember is rule number one: Gambling is gambling, and whether it's investing or blackjack, I bet only what I can afford to lose — typically, less than 5 percent of my portfolio.

Allan Roth is the founder of Wealth Logic, an hourly-based financial planning firm in Colorado Springs, Colorado. He has taught investing and finance at universities and written for Money magazine, the Wall Street Journal and others. His contributions aren't meant to convey specific investment advice.

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