Are single stocks too risky?
If you’ve listened to the Dave Ramsey show for any length of time, you’ll hear him say that he doesn’t invest in single stocks. Instead, he invests in “good growth mutual funds and paid-for real estate”. His reasoning is that single stocks are too risky.
I wonder though, is that true? If you’re talking about putting all of your money into ONE single stock, I totally agree. Of course it’s too risky to put all of your eggs in one basket. That’s like putting it on a roulette wheel. Even putting it all on a few different stocks would be extremely risky.
On the other hand, what IS a “good growth mutual fund”, exactly? It’s a fund that invests in securities. (Usually stocks, bonds, and money market accounts.) Which means…you’re in a variety of single stocks. Plus bonds and money market accounts.
How is that any different from investing in a large number of diversified stocks, bonds, and money market accounts yourself? I don’t think the danger is so much the dreaded “single stocks” as it is in not being fully diversified or choosing stocks without doing thorough research.
Of course a mutual fund manager likely has significantly more experience in investing than most individual investors, which can greatly reduce risk as well. Finally, mutual funds are able to invest extremely large amounts of money, since they are pooling the resources of many individual investors. This gives them opportunities that individual investors may not have. So mutual funds probably ARE less risky than single stocks for the majority of people. (Although it depends on the mutual fund, too.)
But simply to blindly label the whole category of “single stocks” as “too risky” is over simplifying things. I have a problem with that because when people hear a mantra over and over again, they begin to believe it without questioning. One thing I always want to do in investing (and the rest of life!) is question. Questioning leads to understanding, which leads to more informed decisions.
June 30th, 2008 at 11:05 am
Another thing to consider in this arena is that the fees will usually be higher when investing in individual stocks as opposed to mutual funds. Which isn’t really ‘risky’, but it will lower the amount of $ the investor will be making.
June 30th, 2008 at 12:41 pm
Looking at the track record for each mutual fund or single stock is a good idea, too.
June 30th, 2008 at 2:33 pm
If you buy individual stocks and seek diversification at the same time, then you are dilluting your own returns. Diversification = less risk = less return. Therfore, by the time you average in transaction costs you usually come out behind what a good mutual fund can do. They can conduct thousands of transactions at a much smaller cost than an individual.
July 5th, 2008 at 11:08 am
I think for the purposes of Ramsey’s target audience (financially unsophisticated people), his advice is probably good. It’s probably a bad idea to encourage everyday Joe to buy stocks based on a hunch without doing any research. Of course, an experienced investor could definitely buy a diversified basket of stocks as well as any mutual fund manager. The problem is that once you hold more than 4 or 5 individual stocks, it becomes almost a fulltime job keeping up with everything.
July 7th, 2008 at 10:13 am
” Another thing to consider in this arena is that the fees will usually be higher when investing in individual stocks as opposed to mutual funds.”
Not necessarily. If you use a discount online broker like TDAmeritrade or eTrade than you pay a fixed price of, $10 a trade. Which means that buying and selling a 100 shares of a stock that cost, for example, $40 – a pretty average transaction, would be .5% – not that high. Sure, it’ll be more for a more expensive stock, but people often buy more than 100 shares of those.
Also, unless you are trading, you probably don’t buy and sell every stock you own every year. So at any given year, the percentage of your total portfolio value may be lower.
Additionally, when you buy and sell individual stocks you don’t have “capital gain distributions”. You only pay taxes when you actually sell stock with a gain. With mutual funds in a taxable account, you sometimes pay taxes on money you don’t even see.
July 9th, 2008 at 3:53 pm
I think he’s smart to give that advice given his audience mostly are concrened with debt. So be safe he just give a generic way to invest.
I will tell anyone to invest in growth mutual funds or index funds that are not educated of investing.
However I own VISA stock, because I did my homework on it.
But I will not recommend that to everyone
DR is playing the safe route
July 10th, 2008 at 11:35 pm
i agree with several people’s comments….DR’s target-audience are ‘debt-addicts’. With a limited amount of time each day to reach this audience, he has to “genericize” things…..thus, what you write about.
As you become more financially-savvy, you have to adjust his advice/information to fit your needs and desires.
His core-tenants though, are great when it comes to financial basics for the masses.
Interesting post!
July 12th, 2008 at 6:09 am
I agree with Kyle’s first remark. Dave’s audience is not sophisticated enough to buy individual stocks.
The corollary to this is that if you have the skill and interest to create and maintain the 10 stock portfolio, you are well beyond having any interest in Dave.
Joe