What Are the Pros and Cons of Single Stocks in Your Portfolio?
Stocks, mutual funds, or exchange traded funds (ETFs):What is the best option when you want to invest in the stock market?Is it worth the time and risk to have single stocks in your portfolio, or should you instead select mutual funds or ETFs, which give you exposure to sectors you likewithout the risk of placing all your eggs in one basket?
While there are many factors to consider here—like the amount of time you have to dedicate to investing or your tax planning needs—there is one other theory in investing that comes into play. Modern portfolio theoryfocuses on maximizing your return without adding too much additional risk.
To summarize, modern portfolio theory says that there is a point at which you can combine different investments that minimize risk for the entire portfolio while getting maximum returns.
This occurs because when you combine assets, you are diversifying your unsystematic risk, or the risk related to one specific stock.You get this diversification because you buy stocks that have a low correlation to each other so that when one stock is up, others are down.
Key Takeaways
- Many factors go into considering the efficacy of holding single stocks in your portfolio—like the amount of time you have to dedicate to investing, your tax planning needs, and your experience as an investor.
- Pros for single stocks in portfolios include reduced fees, understanding the taxes owed and paid, and an ability to better know the companies you own.
- Cons include more difficulty diversifying your portfolio, a potential need for more time invested in your portfolio, and a greater responsibility to avoid emotional buying and selling as the market fluctuates.
Understanding the Pros and Cons of Single Stocks in Your Portfolio
When trying to get as much return as you can for the least amount of risk, your number one concern should be diversification. While having low fees and managing your own tax situation is good, it is better to have adequate diversification in your portfolio. If you don't have the funds to make this happen, an ETF or mutual fund is probably better for you—at least until you build up a solid base of stocks.
Pros of Holding Single Stocks
- When buying individual stocks, you see reduced fees. You no longer have to pay the fund company an annual management fee for investing your assets. Instead, you pay a fee when you buy the stock and one when you sell it. The rest of the time there are no additional costs. The longer you hold the stock, the lower your cost of ownership is. Since fees have a big impact on your return, this alone is a good reason to own individual stocks.
- You understand what you own when you pick out the stock. You have complete control of what you are invested in, and when you make that investment.
- It is easier to manage the taxes on your individual stocks. You are in charge of when you sell, so you control the timing of taking your gains or losses. When you invest in a mutual fund, the fund determines when to take the gains or losses and you are assigned your portion of gains. This is true even if you just bought into the fund at the end of the year.
Cons of Holding Single Stocks
- It is harder to achieve diversification. Depending on what study you are looking at, you must own between 20 and 100 stocks to achieve adequate diversification. Going back to portfolio theory, this means more risk with individual stocks unless you own quite a few stocks.
- Achieving this diversification is harder the less money you have. Especially when you start investing, you are subjecting yourself to more risk due to the lack of diversity.
- It requires more time from you to monitor your portfolio. You need to ensure that the companies you've invested in aren'thaving business problems that could wipe out your bet. You also need to monitor industry and economic trends. You're your own portfolio manager, so you must spend the time to ensure you're not holding a bad position.
- You must keep your emotions in check. It becomes easier to sell a loser or buy a hot-tip stock because you can instantly log in and make the trade in minutes. This can increase your fees for trading and can also lock in losses that would have been avoidable by holding something a bitlonger.
FAQs
We suggest a 5% rule of thumb to avoid owning too much of a single investment. Often, one large single holding can dominate the performance of the entire portfolio. Remember, even “good” companies can fall on tough times.
Why not to invest in single stocks? ›
Financial pros like Benz urge investors to build broadly diversified portfolios for a reason: While the overall historical trajectory of the stock market has trended upward, any individual stock has a chance to decline sharply in price and destroy your portfolio's returns.
What is a good number of stocks to have in your portfolio? ›
There might be other practical considerations that limit the number of stocks. However, our analysis demonstrates that, whether you own ETFs, mutual funds, or a basket of individual stocks, a well-diversified portfolio requires owning more than 20-30 stocks.
Should I buy index funds or individual stocks? ›
Individual stocks may rise and fall, but indexes tend to rise over time. With index funds, you won't get bull returns during a bear market. But you won't lose cash in a single investment that sinks as the market turns skyward, either. And the S&P 500 has posted an average annual return of nearly 10% since 1928.
How much is too many stocks in a portfolio? ›
Can you over-diversify a portfolio? Yes. Holding 50 stocks rather than 25 may lower your downside risk somewhat, but it can also reduce your profit potential. And at that point, it may be better to consider investing through an index fund, or even a combination of several sector-based funds.
What is the best portfolio ratio? ›
Many financial advisors recommend a 60/40 asset allocation between stocks and fixed income to take advantage of growth while keeping up your defenses.
What is a disadvantage of a single stock? ›
Cons include more difficulty diversifying your portfolio, a potential need for more time invested in your portfolio, and a greater responsibility to avoid emotional buying and selling as the market fluctuates.
What risk do you face when you buy a single stock? ›
If you invest all of your money into a single, expensive stock, you could lose a significant portion of your capital if that stock declines. By diversifying your portfolio, you can reduce your exposure to any stock's risk and minimise the volatility of your portfolio's returns.
Why should an investor hold a portfolio rather than invest in a single stock? ›
While it's tempting to believe a stock's market outperformance will continue, studies show that investments in a diversified portfolio can produce greater long-term wealth than investments in a concentrated position, with significantly less risk.
Is it OK to have 100% stocks in my portfolio? ›
The main argument advanced by proponents of a 100% equities strategy is simple and straightforward: In the long run, equities outperform bonds and cash; therefore, allocating your entire portfolio to stocks will maximize your returns.
A stock portfolio focused on dividends can generate $1,000 per month or more in perpetual passive income, Mircea Iosif wrote on Medium. “For example, at a 4% dividend yield, you would need a portfolio worth $300,000.
How much money do I need to invest to make $3,000 a month? ›
Imagine you wish to amass $3000 monthly from your investments, amounting to $36,000 annually. If you park your funds in a savings account offering a 2% annual interest rate, you'd need to inject roughly $1.8 million into the account.
Should I buy single stocks? ›
If you want the control and involvement of choosing which stocks to own, individual stocks may fit your needs. However, if you don't want to be as involved in the investing process, individual stocks may not be appropriate for you.
What are the best stocks to buy for beginners? ›
Compare the best stocks for beginners
| Company (Ticker) | Sector | Market Cap |
|---|
| Broadcom (AVGO) | Technology | $615.68B |
| JPMorgan Chase (JPM) | Financials | $581.89B |
| UnitedHealth (UNH) | Health care | $455.93B |
| Comcast (CMCSA) | Communication services | $157.06B |
2 more rowsRamsey explained that the main drawback of relying too heavily on one stock is that it exposes you to too much risk. “The core issue here is a lack of diversification,” he wrote in the column. “When you put all your eggs in one basket, there's always some clown twirling the basket.”
Is 10% in one stock too much? ›
Therefore, sticking to the rule of keeping no more than 10-15% of your overall portfolio invested in a single stock may become even more critical of a benchmark to follow both to mitigate volatility, potential returns, and hazards to your overall financial life.
What percentage should a stock be in your portfolio? ›
The common rule of asset allocation by age is that you should hold a percentage of stocks that is equal to 100 minus your age. So if you're 40, you should hold 60% of your portfolio in stocks. Since life expectancy is growing, changing that rule to 110 minus your age or 120 minus your age may be more appropriate.
How much of your portfolio should be in one trade? ›
The 2% rule's main advantage is that it helps mitigate risk and preserve capital. By limiting the exposure of each trade or investment to 2% of the portfolio, investors can spread their risk across multiple positions.
What is the 1% rule in stocks? ›
Enter the 1% rule, a risk management strategy that acts as a safety net, safeguarding your capital and fostering a disciplined approach to navigate the market's turbulent waters. In essence, the 1% rule dictates that you never risk more than 1% of your trading capital on a single trade.
