I don’t actively trade or buy individual stocks, much to many of my friends’ surprise. I mention several reasons why in another blog post, but the main reasons are that:
It takes a lot of work to try to do it correctly
Accurate, timely information on individual companies can be difficult to find
It requires a substantial amount of research on various companies and industries.
The market is volatile and the purchase of individual stocks is too risky
I keep my investing simple by purchasing well-diversified index mutual funds. The index funds lower my risk of losing money and increase my chance of making money. They also increase the odds that I will make a substantial return on my investments over time.
However, I had a few people reach out to me and question this strategy. They asked “if investing in index funds means you purchase all the stocks, then that means you own both good companies and bad companies. Why not just purchase all the good companies individually?”
My answer was that “It’s not that simple.” Let me explain why.
Good company does not mean good stock. In other words, just because you hear of a “good company” like Apple or Microsoft that does not mean buying stock in that company will make you money.
You make money by purchasing stock in a company and having that company’s stock increase over time. Unfortunately, even if a company is good and profitable, that does not mean buying stock in that company will make you money over time.
A company’s stock price is not determined by that company’s value. Some well-run companies can have low stock values and some poorly run companies can have high stock values.
Stock prices are volatile and change quickly based on a variety of factors. If investors think an industry will do poorly over the next few months, their stock price may go down, even if the company itself is doing very well. If investors think a company’s stock is overpriced, they may start to sell that stock which may drive the price down, even if the company itself is still doing well and making huge profits.
Plus, even if a company is doing well and its stock price has increased recently, that does not mean its stock price will continue to go up in the future.
Sometimes a bad company can have its stock price go up (making you money) and a good company can have its stock price go down (losing you money).
It’s hard to predict what will happen.
Picking the right stock relies too much on luck. It is not dependent on skill, intelligence, having the “right” advisor, or extra knowledge. Because it’s so hard to know which companies will have stock prices that will go up over time, buying individual stocks is like gambling in a casino. Although you hope to make money, you can’t predict what will happen. Even if you got lucky and made money initially, that does not mean you will continue to be lucky and make money in the future.
It’s too risky. I’m not sure about you, but I don’t like to lose money. I want to invest in a safe way that will still give me a good return on my investment over time.
I invest in index mutual funds. By purchasing funds like the Vanguard Total Stock Market Index, I am nearly guaranteed to make about 8-10% profit on my money each year. Each year, this return on my investment will continue to increase and compound. This will build my net worth.