7 Reasons Why I Invest in Individual Stocks (2024)

Vault’s Viewpoint

• Buying ETFs is a great way for beginner investors to get exposure to investments and achieve market returns.
• Picking individual stocks can lead to more upside but requires that you monitor your portfolio more often.
• Most funds have several dead stocks that aren’t doing much for total returns. Investing in individual stocks can help investors avoid these duds.

The Potential for Higher Returns

Investing in individual stocks can generate higher returns than mutual funds and ETFs. The opportunity for higher returns is the primary reason some investors prefer to pick individual stocks rather than funds.

Achieving a higher return can help you reach your long-term financial goals sooner. Even a relatively small gap can have a sizable impact on your wealth. If a $10,000 portfolio goes up by 8% each year, it will become a $217,245.21 portfolio. This figure assumes you do not make any additional portfolio contributions.

If that same portfolio exhibited a 9% annualized return, it would be valued at $314,094.20 after 40 years. A single percentage point adds almost $100,000 in additional value for a $10,000 portfolio over 40 years. The cap will expand if you frequently contribute to your portfolio and get your total contributions well above $10,000.

Better Tax-Harvesting Opportunities

A mutual fund or ETF contains many stocks that gain and lose value. Fund investors don’t have the cost basis for every individual stock, which limits how much they can write off each year.

Assume two equally weighted stocks have different trajectories. One of those stocks increases by 50% while the other drops by 50%. If one $1,000 investment turns into $1,500 and another $1,000 investment turns into $500, you’re at breakeven.

The fund shows breakeven, but investors with individual stocks can distinguish between the outperforming stock and the investment with a capital loss. The investor with individual stocks can sell off some of their positions at a net loss and wait at least 30 days before repurchasing shares to avoid triggering the wash sale rule.

Mutual fund and ETF investors don’t have the same flexibility with tax harvesting. They must sell shares of the entire fund rather than individual picks within a portfolio. Stock pickers can also put their money into a similar stock while waiting for the 30 days to pass. For instance, you can sell one cybersecurity stock at a loss and temporarily put those funds into a similar cybersecurity stock.

Ideally, neither investor has to sell at a loss. Tax harvesting is a great strategy, but it’s not an excuse for bad investing. But short-term opportunities can present themselves and allow you to lower your tax bill if you buy individual stocks.

Avoid “Dead Money” Stocks

Receiving a basket of stocks from funds gives you plenty of diversification. But more portfolio diversification isn’t always better. Approximately 25% of stocks in the S&P 500 are down over the past five years, and the S&P 100 has outperformed the S&P 500 during the same stretch. The S&P 100 only has the top 100 stocks, while the S&P 500 has the top 500 stocks. Mutual fund investors are getting stuck with “dead money” stocks.

Even though I primarily buy individual stocks, I still invest in the Vanguard Growth Index Fund ETF (VUG). People who prefer to pick stocks can still benefit from ETFs, and this fund has a history of outperforming the S&P 500. But there are several stocks that I don’t like in this fund.

Underperforming Stocks in VUG

Although VUG has outperformed the S&P 500, these are some of the stocks you’ll find in VUG:

I’m concerned about Tesla stock’s valuation and competition cutting into revenue growth, and the stock is down by 34% year-to-date. Nike has only been up by 3% over the past five years, while the other three stocks on this list have lost value over the past five years. There are more stocks that have lost ground over the past five years, but I decided to focus on those picks.

Funds that mirror the S&P 500 and the Nasdaq 100 spread their capital among investments based on market caps rather than fundamentals. That’s why Microsoft is VUG’s largest holding (12.84%) while Apple is its second largest holding (11.15%).

Apple’s large position in the fund also concerns me since the stock has only been up by 3% over the past year and down by 9% year-to-date. The stock currently trades lower now than it did at the end of 2021.

While I could find more issues by digging deeper, I am concerned about how 15% of the fund’s total assets are allocated. I’ll still buy this fund because it has outperformed the market, but I’m putting most of my money into individual stocks.

No Expense Ratio

Not having an expense ratio is a nice bonus that comes with picking individual stocks. Granted, passive investors can find ETFs with very low fees to the point where it barely impacts total returns. For instance, VUG only has a 0.04% expense ratio.

Expense ratios can get higher if you don’t want to follow a passive benchmark or index. The ARK Innovation ETF prioritizes speculative growth stocks and has a 0.75% expense ratio. That ratio will have a more notable impact on total returns than VUG’s 0.04% expense ratio.

Buying Dips

Many investors buy dips to reduce cost basis and accumulate more shares. While this is a common practice among stock pickers and fund enthusiasts, people with individual stocks can capitalize on dips more effectively.

Individual investors can buy stocks when they drop due to company-specific reasons. Fund investors do not have that flexibility since other stocks will prop up the fund. For instance, Alphabet recently lost value over its Gemini blunder, prompting the stock to enter a correction.

I viewed the dip as a buying opportunity since Alphabet’s advertising and cloud computing financials shouldn’t be affected by the Gemini mishap. Buying individual stocks allowed me to build up my Alphabet position at a discount when it entered a correction. Meanwhile, VUG has not yet entered a correction in 2024.

Funds can mask dips within individual stocks. Investors who stay on top of their picks can detect these dips and determine if they are justified or not. If the company’s fundamentals aren’t impacted by recent news, it can be a good buying opportunity, but investors have to make their own judgments.

More Control

Earlier, I mentioned a few stocks in VUG that I’m not fond of at the moment. My preferences aren’t going to have any impact on how managers allocate the fund’s assets.

Buying individual stocks gives me the flexibility to ignore stocks that have large concentrations in various funds. I can also build larger positions in the stocks that I like the most. Funds that track the S&P 500 and the Nasdaq 100 are prioritizing stocks with the highest market caps. This approach is inefficient and has led to missed opportunities.

Microsoft and Apple are the two leaders for most funds, while smaller companies with higher 5-year returns, like Arista Networks and Crowdstrike, don’t receive as much capital from funds. I don’t have to worry about how funds choose to allocate their capital since I put most of my money into individual stocks.

I Have No Problem Researching Companies

Investing in individual stocks requires you to research companies, read press releases and analyze earnings reports. You’ll also have to look at valuations, compare competitors and decide which long-term stocks are right for you.

I enjoy researching companies and finding opportunities. I look for companies with expanding profit margins and good growth opportunities. Most of my portfolio consists of large-cap stocks, including some members of the Magnificent Seven.

Not everyone has time to do their research. You don’t have to research stocks every day, but you have to stay on top of earnings releases. Those reports offer a glimpse into how a company is changing in real time. Most of the research comes before you buy a stock. Then, it’s a matter of monitoring your investments and their theses.

Should You Invest in Individual Stocks?

Investing in individual stocks can help you outperform the stock market. But it’s not for everyone. These are some of the questions you should ask yourself before investing in individual stocks:

• Can I monitor my portfolio and do research multiple days per week?
• Is beating the stock market necessary to achieve my long-term goals?
• Do I enjoy analyzing stocks and discovering new opportunities?
• Do I want an easier path to stock investing that takes less time instead of picking individual stocks?
• What characteristics determine a good stock from my point of view?