When you are just starting you might be thinking that you are supposed to purchase individual companies’ stocks to invest. For a beginner how to know what stocks to buy can be quite a puzzling question.
I can tell you now that it definitely is not the only option to buy stocks and probably not even the best option even for most investors. I will look through the popular investment options and give you my opinion about all of them.
Individual Stocks
Since you are reading this article I assume this investment type you already know. Individual stocks are one of the most popular and well know investment types out there. The only question for you remains how to know what stocks to buy.
Picking individual stocks yourself without prior knowledge is not recommended. They are risky and volatile, so you must know what you are doing. Buying just one or two company shares that you like is not an investment strategy. I would call that more of a gamble. You could have a good run but most likely you would lose money.
Either way, when talking about a diversified portfolio including some of them might be a good idea.
Advantages And Disadvantages of Individual Stocks
- More Control
Individual stocks give you more control over your investment portfolio. You can diversify it as you like including all the growth, value, small-cap, large-cap, and other types of stocks. You also can choose industries in which you want to focus, what companies to avoid, and in what companies you want to put more money.
- More Targeted
When you choose another investment option will likely be buying all sorts of companies. With individual stocks, you can pick 20-30 stocks that you like and get higher returns.
- Less Diversified
The drawback with individual stocks is that probably you will not be owning 500 stocks like buying S&P 500 index fund. Because of that, your portfolio will be less diversified, therefore, it can be riskier.
- More Personal
Picking stock yourself means that you will be more involved in the processes and do your research. As this can be a good thing beware that it will take more of your own time.
- Note On Diversification
There are a lot of opinions on how many companies you should buy to consider your overall portfolio diversified. Having 20-30 companies is the recommended average. With fewer companies, you are not diversifying your portfolio that much, and with more stocks, you might be over-diversified. Thus you limit your potential gains. Having too many stocks can also be too hard to track and manage. According to popular opinion, one stock should never take more than 5-10% of your portfolio as you get too dependent on it.
- To Diversify Look Into Different Types Of Companies
To have a diversified portfolio you should also look into different industries, different company sizes, and styles.
You should read more about them in my other article – ‘3 Types Of Stocks That You Need To Know‘.
Mutual Funds
When trying to answer the question of how to know what stocks to buy I believe that mutual funds should be mentioned in this list. Mutual funds still control a lot of money and do quite a large impact on the market due to their size.
However, in my opinion, high taxes and high entrance requirements make this investment type hard to enter.
Advantages And Disadvantages of Mutual Funds
- Risk Management
A pool of investors sharing risk and reward when investing in mutual funds. So, this is a safer option than investing in stocks by yourself.
- Diversified Holdings
Mutual funds are kept diversified, so they provide less risk overall. Different funds focus on different types of companies or they can be trying to diversify as much as possible. However, due to their size, they have to avoid small-cap and mid-cap companies. In most cases as the funds would affect these companies’ stock prices too much.
- Professional Management
Mutual funds are managed actively and passively (index funds).
Actively managed funds have the advantage that a human will select companies based on knowledge whereas index funds have preset rules on how to invest. This is quite controversial. When there is no manager there is no human emotion that can make a bad decision.
- Liquidity
Mutual funds are easy to sell at any time as they are popular and there will always be buyers.
- High entry
Most mutual funds have a minimum investment sum that you have to invest. Mutual funds usually start at 50.000 USD to entry, and index funds can have this sum of around a few thousand dollars.
- Expenses
There are a lot of expenses associated with mutual funds.
Expenses For Mutual Funds
1. Sales Charges (load ~3%) – actively managed funds asks you to pay 3% on average just for the privilege of working with them. Because of this point, I would never consider investing in an actively managed fund. Index funds usually do not have this charge.
2. Expense Ratio (1%) – On average mutual fund charges 1% for operating expenses and marketing. This alone is not that bad as you usually have some expenses with other investment types. However, usually not that high.
3. Other Charges – There can be a lot of other charges associated, so you have to read the expenses sheet carefully before investing.
4. Redemption Fee (~1%) – This fee is quite common with mutual funds. It means that you have to pay a fee if you want to sell your position before the agreed term.
You can find these expenses on the Yahoo Finance website and easily compare them.
Equity Trading Funds (ETF)
When considering how to know what stocks to buy these funds can be considered as a lighter mutual funds version. You can purchase a lot of different index funds as stocks through brokers, and online brokers. You can find practically any kind of ETF. For example, you can search for AI index funds and find at least 5 companies that use AI in their products or services.
Advantages And Disadvantages Of ETFs
1. Large Diversification – S&P 500 following funds are just one type of ETF. You can find ETFs that consist of 1000 stocks or even more. This ensures that you really own a large portion of the stock market with just one purchase.
2. Typically Tracks an Index – Most ETFs track some kind of index funds and set them as a benchmark. This works pretty well as most of the S&P 500 following indexes have the same returns or 0.1% lower, which is not that bad.
3. Low Expense Ratio – Expenses for ETF usually are minimal. Most likely you will have to pay taxes when you make a purchase or make a sale. In some cases you might receive dividends, so you would also have to pay taxes for them as income.
4. Traded On The Market Like a Stock – Trading ETFs is as easy as purchasing stocks, which can be bought through brokers or most online brokers.
5. Price Changes During The Day – ETFs have the same trading hours as stocks, so it depends on which exchange a particular ETF is sold.
6. Liquidity Like With a Stock – There is a large number of buyers and sellers, so you will not have problems cashing out whenever you need to.
7. Pay Commission To a Broker Like a Stock – As I mentioned before usually there are no additional fees when purchasing an ETF.
8. Can Buy Just 1 Share – There is no minimum sum which you have to invest like with other mutual funds. You can simply purchase 1 ETF stock.
Because of these reasons, I believe that ETFs have a distinct advantage over other investment options that can give you diversification without any hustle.
Stocks And ETFs
A lot of investors that I know or the ones that I have listened to in podcasts have a strategy of buying ETFs as a majority of their portfolio. The other part is purchasing some individual stocks on the side.
Quite a Safe Option – strategy does pretty well as long as the market is doing good, and it is for most of the years. When you purchase one or several ETFs for most of your portfolio you can try to expand your diversification. You can do that with low-cap, or mid-cap stocks to fill in the gaps your ETF portfolio does not cover.
Better Diversification – Another reason to purchase some stocks on the side is, for example, if you purchase an S&P 500 following ETF you might want to balance out the high investment portion on the technology sector and put some of your money into some safer stocks that do well when the market overall is not doing so great. So, this is a good way to look when you ask how to know what stocks to buy.
80% ETFs, 20% Stocks – When talking about proportions a suggestion that I saw is owning 80% of ETFs. For example, S&P 500, Total stock market, or International indexes following ETFs and buying some other individual shares as your other 20% portfolio.
Of course, everything is okay if you want to make your portfolio with only ETFs. This actually may be an excellent option for people who do not have much time to spare. Picking and tracking stocks yourself can take up a lot of your time.
However, if it is too boring for you to own just one or a few ETFs you might want to do the analysis and make a strategy yourself. In that case, you are more than welcome to do so. Actually, I use this strategy as I invest most of my money in ETFs and a smaller portion of my portfolio consists of a lot of different investment options.
Doing this can also make you higher returns than with just ETFs if you made the right decisions when choosing your stocks.
Conclusion On How To Know What Stocks To Buy
- Individual stocks require a lot of work, but are very versatile and can give you high returns
- Actively managed mutual funds should be left alone for institutions to invest into
- Passively managed mutual funds are a great investment option that is diversified and can give you market average returns.
- Equity trading funds (ETFs) are better than passively managed mutual funds: even fewer expenses and fewer restrictions. An excellent option for beginners and can be the only option for even experienced investors.
- Mixing ETFs with individual stocks is a viable option for most experienced investors.
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