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When it comes to investing, you’ve probably heard this advice countless times: Diversify! As an adviser, I’ve given this counsel innumerable times, and I couldn’t agree with it more. When you own thousands of stocks in a low-cost index fund, you have far less risk than if you own a handful of individual stocks. I’ve written about former blue chips like General Motors, Eastman Kodak and GE that lost most or all of their value. Though this should be reason enough to avoid individual stocks, here are five lesser-known reasons.
1. You’ll probably earn less
Intuition tells us that roughly half the stocks will beat the total market and half won’t. But intuition is typically wrong when it comes to investing. A 2020 study by Arizona State University’s W.P. Carey School of Business evaluated lifetime returns for every U.S. common stock traded, and 96 percent earned about the same as a one-month Treasury bill. A handful of stocks drive the return of the stock market. The stars of yesterday are unlikely to be the stars going forward.
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Betting on a few select stocks may make your rich if you choose the right ones, but the probabilities are against you. Just as a lottery ticket may make you rich if you win, the overwhelming odds are you will lose. Experts are often wrong, as illustrated by Mad Money’s Jim Cramer touting the stock of Silicon Valley Bank weeks before its failure.
2. Proxy voting
Publicly traded companies have an annual shareholder meeting. Chances are you won’t be attending, but you will have the opportunity to vote a proxy for such items as the composition of the board of directors or even selling the company to another entity. I personally have never met anyone who takes the time to read the multitude of pages and research the issues in a proxy. I’d argue that if you own a dozen or more individual stocks, you could spend the entire year researching the issues and board nominees.
If you own through a diversified low-cost fund, you don’t have to do anything. That’s because fund families, like iShares, Vanguard, Fidelity and Schwab, give the shareholder a voice by researching for you.
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