Stock-picking: Have you got what it takes?

-- | 21/07/2020

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Ruth Saldanha: A recent tweet by my colleague Christine Benz, Morningstar's Director of Personal Finance, generated a lot of interest on social media. She said that individual stocks are terrible investments for people just starting out. Many agreed saying that most new investors might not have the knowledge to pick stocks. Others disagreed saying that though they lost money, they learned a lot, so the lessons were overall worth it. Still others managed to hit it out of the park. They timed their stock market purchases just right and ended up making a lot of money. But we think that for new investors, it is still not a good idea to try and pick stocks. Christine is here today to talk about why this is.

Christine, thank you so much for being here today.

Christine Benz: Ruth, it's my pleasure. Great to be here.

Saldanha: First up, why is picking stocks not for everyone?

Benz: Well, I think, it's important to remember that most professional investors have not managed to beat the market over time. So, I think that that should sort of put a thought in individual investors' heads about why they might not be able to do any better. And then, I think, especially for younger investors who are just getting their investment programs off the ground, it's really important to remember that as a small investor even though there are some new programs that allow fractional share trading, for example, it can be really difficult to be diversified as a small investor. So, a fund or an exchange-traded fund gives you a lot of diversification in a single shot. From that standpoint, it helps take the risk out of your portfolio and you can just get your money working for you sooner in a more diversified basket of stocks.

Saldanha: One of the main counterpoints to your tweet was that losing money through stock picks was a major learning experience for some investors. Is this a valid idea that you have to lose money to make money?

Benz: Well, I was initially compelled by the idea and I certainly heard it from some really smart investors that they felt that they had learned by making mistakes. I guess a counter argument I would make though is for young investors, people in their 20s or 30s, those are really valuable years to have money working on your behalf. So, there is an opportunity cost associated with dabbling individual stocks, learning your lessons before you get serious about investing. And then, another counter argument I would make is that it's rare in other spheres of human endeavor where we would say, well, just out there and make some mistakes and figure it out. So, the analogy I used was fixing my car. I am not equipped to fix my car, and no one would suggest that I go out and try to muddle through and figure it out and learn some lessons along the way. I'm much better hiring a professional. If I'm seriously interested in fixing cars, maybe I can read some books, maybe I can take some classes, but I shouldn't begin, especially with something as important as investing, by dabbling and potentially making some big mistakes.

Saldanha: What about some of one-off stars, the ones who manage through sheer luck mostly to time the market perfectly and then end up rich? Is something like that worth the gamble?

Benz: Well, that's I think something that a lot of the young traders have been compelled by. They've seen some of their peers perhaps investing in individual stocks and have hit home runs. I think that there can be kind of a gambler mentality that takes hold where – as you know, gamblers often tend to remember when they won money. They forget when they lost money. So, I think that that's a risk factor. I think that investors probably shouldn't want to emulate professional investors because it can be really difficult to beat the market consistently.

Saldanha: But do small investors always get it wrong in a manner of speaking?

Benz: They don't. And I would say that small investors, retail investors, individual investors do have some really valuable advantages on their side. One is time. So, they aren't having their results published in the newspaper or on Morningstar. They can take their time and wait for their holdings to recover. So, I would say time is a big advantage. They can get to know their portfolios and run with a fairly narrow basket of stocks if they so choose. They can also be more tax-efficient than fund managers can be. And then, another important advantage that the individual investors have that the pros don't have is that they are not having to contend with inflows, funds coming into their portfolios and funds leaving their portfolios perhaps at inopportune times. So, small investors do have some advantages in their favor. That's why I wouldn't write it off entirely, especially for more seasoned investors who know what they are doing.

Saldanha: How should investors who are just starting out begin their investment journey?

Benz: I really like the idea of starting diversified. You could go with a globally diversified basket of stocks. Or you could use some sort of a target date vehicle that's age appropriate. That will also be quite stock heavy. I think you want to keep in mind that as a young investor assuming you are saving for a very long-term goal, you have an attractive advantage in that you have time on your side that you can wait out periods of market weakness as long as you keep investing. That's your main advantage and that will help get you to your financial goals. I also think it's really important for young investors to remember if they have shorter-term goals and most of us do throughout our lives, have shorter-term goals, that they invest that money appropriately. So, if they are planning to make a home down payment or pay for a wedding or pay for higher education or whatever it might be, they would want to make sure that they have that money set aside in safer investments. Stocks probably won't be appropriate for those near-term goals.

Saldanha: Finally, what are some investment good habits that investors who are just starting out can cultivate?

Benz: One of the best ones is just to get yourself in the habit of investing, really take the guesswork out of your investment program by committing to invest regular sums on an ongoing basis. And the nice thing is, is that you can really start small with many investment providers as long as you are willing to sign on for an automatic investment plan. You can get started with a small amount. And that discipline can be just incredibly impactful because it will keep you investing through good markets and through bad ones as well. So, I would say that that's a key starting point for many investors.

Another good habit is just to not pay that much attention to how your investments perform on a day-to-day basis. Things go up; they go down. But over time over market history we tend to see that investments, stock investments of broadly diversified basket tends to perform pretty well. It beats other major asset classes. So, try not to pay attention as Vanguard founder Jack Bogle said, don't peak and your portfolio will be a lot better off in the long run.

Saldanha: Thank you so much for joining us with your perspectives, Christine.

Benz: Thank you, Ruth. My pleasure.

Saldanha: For Morningstar, I'm Ruth Saldanha.

This report appeared on www.morningstar.com.au 2020 Morningstar Australasia Pty Limited

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