The Advantages of Owning Individual Stocks

Sometimes, it's easy to divide investors into two camps. There's the active-fund-management camp and the index-fund camp. There's the traditional mutual fund camp and the exchange-traded fund camp. And, of course, there's the fund camp and the individual-stock camp.

In all these cases, there's really no need to choose one side or the other--why not use both if it works for you?--but there are still those who feel that one way is better than the other. So, last week, when we asked readers on our Personal Finance discussion board whether they prefer investing in individual stocks or stock funds, many responded with well-reasoned explanations as to why they invest the way they do. The majority of respondents said that individual stocks make up a significant, or even a majority of, their portfolios and explained why. Others spoke up on behalf of a funds-only approach. Either way, readers provided some thought-provoking responses for anyone trying to decide which approach to take.

You can read the full discussion here. It includes the comments that follow.

'The Best-Kept Secret Out There' Readers who invest primarily in stocks provided many different reasons for doing so. One was to have greater control over their portfolios.

For example, DollarBits wrote, "I want the ability to buy when companies are selling well below (Morningstar's) fair value assessment and consider selling when companies that I am investing [in] are selling well above (Morningstar's) fair value assessment."

Reader andymoler58 suggested that stock investing doesn't get the attention it deserves. "Buying individual stocks is the best-kept secret out there," he wrote. "You can screen out the garbage from the indexes and buy only the strongest companies out there with the best balance sheets. You can also screen the stocks on volatility to see where your comfort level is. Then you get to take advantage of the volatility in the stocks to buy more when they go down. And you never have to sell, which eliminates the tax implications. I hope the index craze continues and no one catches on to this."

For reader acamus, choosing to own stocks comes down to several different factors, including the fact that he can trade stocks cheaply.

The commenter wrote, "The threshold portfolio size at which costs become higher using equity funds rather than individual stocks, even with low-cost index funds, is actually pretty low. That's the main reason for me; it's cheaper for me to own individual stocks than equity funds. The other reasons are tax-related. If one invests in an equity fund, one can take on an unexpected tax liability, especially at the present time with many equity funds having considerable unrealized capital gains. ... [Also], by holding stocks individually, I have greater flexibility when it comes to tax-loss harvesting. If I owned a fund, even if some of the fund's holdings had a loss, the fund itself might have a gain. That means I wouldn't be able to realize the individual losses, whether short term or long term, for tax purposes."

Acamus wasn't alone in preferring stocks over funds--at least for now--due to the tax treatment of each.

Mlott1

wrote, "Times like these, when the overall stock market is at or near all-time highs, I'm reluctant to invest in a mutual fund as I'm buying all of the underlying stocks at high prices. ... If and when we have another market correction, I'll consider mutual funds--I have a watchlist. But for now, I think I will get more bang for my buck by selectively buying stocks that I think are at an attractive price, like

In some cases, investors said they choose the investment vehicle by account type. For example, dragonpat said she only holds individual stocks in her taxable account while holding stock funds in her 401(k) and Roth IRAs.

"Mutual funds throw off annual capital gains distributions that I have to pay taxes on in addition to the dividends," she said. "I also use tax-loss harvesting to keep the capital gains on the individual stock shares I do own down to the best that I can."

'They Both Serve a Purpose' Another area of emphasis among some retired readers who favor stocks over funds was dividends. Several said that by picking individual stocks they are better able to execute dividend-based income strategies.

"I am retired and need income from my investments," wrote Scott43. "Stock mutual funds can earn around 3% dividends, but by buying individual stocks, I can get about 4.5% with a basket of 20 stocks."

For Rohit33410, owning individual stocks has helped pick up the slack from sagging bond yields.

"I own dividend-paying stocks, which provide predictable quarterly (and often increasing) income," he wrote. "As corporate bond yields have fallen to 4% in recent years, I find the prospect of earning a 3% dividend on large, stable companies like

Other readers also mentioned how they subdivide the equity portion of their portfolios among stocks and funds depending on the need.

For instance, ARI321 wrote, "They both serve a purpose. I am invested (67%) in equities--half in individual stocks for dividends, half in stock funds for growth and diversification. [I] only trade stocks occasionally, when something is on 'sale.'"

Another less-active stock trader is VTskeptic.

"I only invest in individual stocks that represent businesses I understand, like

Beating the Street

a long time ago. The book is the best argument I've seen for eschewing professional money managers and the complex intellectual models they spin."

Reader proxysteve, who said he holds about 40 stock positions that make up 22% of his portfolio, said stock investing keeps his costs low and allows him to take more of a long-term approach than fund investing.

"In my opinion, most active managers ... have too short a time horizon," he wrote. "In fact, even ones who say they don't mention a 3-5 year holding period. That is still short term in my view. I prefer stocks I can hold for decades (or even for my entire life)."

He said another reason he invests in stocks is that "I enjoy it. A lot. It started as a hobby, but now it's my second job, and one I enjoy more than my daytime job. It's not for everyone. You need to have the knowledge, interest, and passion to do it."

In a few cases, readers who had been heavy stock investors said they've pulled back or are transferring more of their assets into funds.

Ret. Fin. Prof. wrote, "I am retired and was seeking income. I concluded that a portfolio of high-quality stocks that paid a decent dividend would be ideal--lowers cost, risk, and easier for tax management. ... I found it to be too much work as I had more than 20 securities spread over two retirement accounts and a taxable account. Aside from monitoring, there was the process involved in reinvesting dividends. Don't misunderstand. I think it's a good approach for one willing to invest the time. I prefer other pursuits, and so I sold the securities and invested in high-quality dividend funds and ETFs."

Reader grumpy put it more succinctly.

"I'm still over 50% individual stocks, but I'm slowly moving into ETFs and mutual funds because I'd rather be surfing," the commenter wrote.

'More Trouble Than They Are Worth' A handful of readers said they have no interest at all in investing in stocks individually.

One, gtoerr, was adamant about it.

"Nope, nuh-uh. Never again," the commenter wrote. "I learned the hard way that I don't have the time, inclination, or resources to investigate individual stocks thoroughly enough to make good choices, nor can I trust my neighborhood investment advisors' recommendations. Therefore, I now only use actively managed funds for stock-picking. Those funds' management teams are much better equipped to make individual stock selections."

And gtoerr wasn't alone. Reader bgstuhan wrote, "Most of the time, individual stocks are more trouble than they are worth. I have to do far more research before buying a stock than a fund, and pay more attention to it after I buy it. Buying individual stocks also leads to unbalanced allocations and big tax hits when I sell. Thus, the only time I buy individual stocks is when they appear to be significantly undervalued compared to the overall market, generally due to market overreaction."

Rayon11 said he or she prefers allocation funds run by managers with strong track records and that charge low fees and have low turnover.

"I am willing to pay the pros to do the homework on individual stocks," rayon11 wrote. "I don't even look at my holdings for most of the year."

Finally, for reader urodoc45, the volatility that can come with owning individual stocks is the issue.

"I have very few individual stocks," the commenter said. "The rest of my personal and retirement portfolio is in mutual funds and ETFs. I have learned my lesson over the years that I cannot stomach the volatility of the price swings of individual stocks. With mutual fund/ETF investing, one may not make you very rich but also will not lose your shirt."

Some comments have been edited for clarity and brevity.