Investing in the stock markets allows you to potentially grow your money over the long-term. However, there are several ways to get exposure to stocks.
When people think about investing in stocks, their minds sometimes turn towards buying individual stocks. That is, they imagine buying the shares of specific companies (like Disney, GE, or Microsoft). I’d suggest that this is not the best way to do it, especially for somebody who is just getting started investing. Why? Investing in stocks is a pain. If you want exposure to the stock markets, you can get it much more easily with mutual funds and ETFs.
Research a Company
The main reason to avoid investing in stocks directly is that you have to do research. If you enjoy that sort of thing, you might be cut out for a career in finance. However, most people have to spend their time in other ways, and investment research is done in their “free” time. Even if you enjoy it, it’s difficult to find the time to properly research stocks.
Investing in stocks may lead to neck pain and eye strain.
To do an adequate job, you really need to know a lot about a company’s industry (including competitors) and you need to understand a company’s strategy. Who are the people in charge, and what are they trying to accomplish? How do the financials look (price-to-earnings, book value, EBITDA)? It’s a lot to keep track of. But it can be done if you scour the annual report, dig through data-rich websites, and dial into shareholder conference calls.
What about technical analysis? If you invest in stocks using charts and other technical indicators, you might not have to do quite as much work, but you’re not off the hook entirely, and you still have to deal with the issues below.
Some people do very little research without disastrous results, but personally I’m not comfortable betting on a company unless I know a lot about it.
Watch Closely
Once you buy a company’s stock, you can’t just forget about it. You need to continue to monitor your investment unless you truly intend to be a buy-and-hold investor (most people who invest in individual stocks don’t go very long without checking in on them). In addition to watching your holdings, you’ll need to keep track of developments in the economy and the markets. You constantly need to evaluate new information (whether it’s a news release, a global event, or a technical signal) and decide whether or not it means you should do something.
Buying stocks can be exciting. Monitoring them is much less enjoyable (if it even happens). For many, the task falls by the wayside as other priorities bubble up to the top of the to-do list.
Order Entry and Trading
When you invest in stocks, you have to enter buy and sell orders for all of your trades. It’s not that difficult once you get the hang of it, but it’s not the simplest thing in the world either.
Market Hours: probably the worst part about entering orders is that (for most of us) you can only trade during market hours. Do you have time to do this during the day, and do you want your schedule to be dictated by market hours? Sure, you can enter orders the night before and just let them fill wherever they happen to fill, but my hunch is that most stock traders have specific prices in mind where they want to buy and sell. You can even use limit orders and stop orders to handle things while you’re away from your computer, but goofy things sometimes happen in the markets (such as the recent “flash crashes”).
Commissions and fees: in addition to manually entering trades, you have to pay transaction fees when you invest in individual stocks. The same is true with ETF’s and some mutual funds, but it’s easier to get diversified with a single trade when you use those instruments. Moreover, mutual funds often allow you to make automatic monthly investments at no charge, whereas you’ll probably have to pay a commission or transaction fee to do this with stocks.
Rinse, Repeat
You do want to be diversified, right? Not only do you want to avoid having everything in the wrong place at the wrong time, but it might be nice to improve your chances of being in the right place at the right time. So you’ll have to do all of the above with a number of different stocks.
Is it Worth It?
It might sound like investing in stocks is going to become your new full-time job. If you can pull that off, then that’s great. But most people end up giving their stocks less attention than they deserve, or just getting overwhelmed and frustrated with the demands of picking stocks.
What are your goals? if you want to be a stock trader or an analyst, then all of those activities might help you reach your goal. But if your goal is something different, such as planning for retirement or investing for a child’s education, you might find that investing in individual stocks is just not worth it. Maybe your time is better spent on other things, like earning an income, playing, or spending time with loved ones.
Alternatives to Investing in Stocks
So what should you do if you don’t want to spend all of your time and brainpower on researching stocks and managing your account? A good solution is probably to use mutual funds or ETF’s. These investments allow you to choose one fund, which then invests in many different stocks (or bonds, or other things, depending on the fund).
There is a lot of debate out there regarding “passive” versus “active” investing. The question is: can anybody pick stocks that will beat the market (even if that somebody does it for a living, and doesn’t have to juggle a separate career and family like you might have to)? If anybody can, it’s probably somebody who has spent a long career buried in their office staring at spreadsheets. But you don’t have to depend on anybody’s stockpicking ability if you don’t want to. If you believe in passive management and the lowest costs possible, use index funds. If you believe in the value of a manager, use active funds. Or use some of each.
Asset allocation: no matter what type of fund you choose, the easiest way to invest is probably to use an “asset allocation” fund – they’re available in both active and passive flavors. In addition to investing in many different stocks, those funds invest in many different types of stocks (and/or other investments). For example, they might own not only the stocks of large companies located in the United States, but also the stocks of smaller companies, and stocks of foreign companies. Add in a few different types of bonds, and you’re starting to get diversified.
How can you use asset allocation funds and avoid investing in individual stocks? There are two main types: target date funds and target risk funds. Pick one that will help you meet your goals, and then go enjoy your free time.
Photo credit: By Kevlangdo (Own work) [CC-BY-SA-3.0 (http://creativecommons.org/licenses/by-sa/3.0)], via Wikimedia Commons