I love to pick stocks. There’s nothing quite like the thrill of researching a company, analyzing its financials, digging into its business model, and making a decision on where my investment-ready cash is going. And then I get to show you the whole process, from finding the first glimmer of promise to slamming the “buy” button with both hands. It’s what I do, and I wouldn’t change it for the world.
But selecting stocks one by one works only as long as I get to grab a whole bunch of them. You know what they say about eggs and baskets.
The thrills and spills of stock-picking
There is no such thing as a risk-free investment.
For instance, Netflix (NFLX) continues to deliver fantastic results and great shareholder value. This stock has made me a lot of money over the years, but the media-streaming expert’s stock is also prone to deep dives every now and then. What if I needed to cash in my Netflix stock at the bottom of the Qwikster conundrum, or after a slowdown in subscriber growth drove share prices 77% lower in 2022? Clearly, this ticker isn’t suitable for a full commitment to a single ticker.
And Netflix isn’t uniquely risk-packed. In fact, every business always faces a mix of obvious and unknown risks. Google parent Alphabet (GOOG) (GOOGL) may have looked invulnerable for years, but now everyone is concerned about artificial intelligence bots stealing the online search market. Oil giants like Chevron (CVX) and ExxonMobil (XOM) used to be paragons of unassailable value, but now they face challenges from renewable energy sources and electric vehicles.
And it gets worse, too. Enron was the kind of highly respected blue chip were people would feel comfortable parking their entire life savings and nest eggs. Lehman Brothers was the fourth-largest investment bank in America, actively advising people on how their money should be managed. Going all-in on Lehman stock in 2008 or Enron in 2001 would quickly leave you with nothing. Remember, these were highly respectable businesses, until they weren’t.
Finding inspiration in Berkshire Hathaway
Stock-picking can work, but only if you set up a diverse portfolio across different industries, geographies, and business models.
Look at Warren Buffett’s Berkshire Hathaway (BRK.A) (BRK.B) as a great example to follow. To simplify Berkshire’s investment history, its portfolio was built around insurance companies and banks, then extended into retailers and restaurant chains. Today, Berkshire’s holdings have expanded into sectors Buffett would never have touched ten or twenty years ago, like video game studios and microchip makers.
And Apple (AAPL) accounts for 42% of Berkshire’s invested assets. The iPhone maker’s portion of the Berkshire collection is so large, I wouldn’t be surprised to see Buffett’s team taking some of their Apple profits off the table to redeploy it in other ideas. It’s one thing to let your winners run, and another to let them dominate your portfolio.
I don’t care how respectable your favorite company is, how guaranteed its long-term success might be, nor how much you trust its management. There is no single stock, bond, cryptocurrency, real estate parcel, or other one-trick pony that can be trusted to carry your entire net worth.
Even the safest bets aren’t worth the risk. No, not even Berkshire Hathaway, even though its own investments constitute a broadly diversified portfolio. How deep is Berkshire’s bench when Warren Buffett and Charlie Munger aren’t running the show anymore? Owning some Berkshire stock makes sense, and you could make it the centerpiece of your own stock holdings with an oversize investment. But it shouldn’t be 100% of your nest egg.
ETFs: The ultimate stock market safety net
If you really can’t — or don’t want to — piece together your own stock collection with a couple of dozen tickers, there is still an easy way out. The trick is to choose a passive exchange-traded fund (ETF) that simply tracks a popular market index with dozens, hundreds, or even thousands of stocks. If one or more of the individual companies inside your chosen index turns out to be a bad egg, you’ll see a limited price drop in your ETF but life goes on. The failed stock will soon be replaced and you’ll continue to share the gains of the broader market.
Popular options include ETFs mirroring the components of the S&P 500 (^GSPC) or Russell 3000 indexes. Passive funds like the Vanguard 500 Index Fund (VOO) and iShares Russell 3000 (IWV) offer large collections of diverse stocks, featuring expense ratios that are low because of the automated nature of index-tracking investments.
So if I could only pick one ticker to hold my life savings, it would be one of these index-tracking ETFs. There is really no other choice under those circumstances.
And here’s the best part. You can always start your investing experience with one of these safe and sound ETFs, then add in specific tickers on top of that fundamental base as you get more comfortable with the stock market.
And if it turns out that stock picking isn’t your cup of tea after all, you can always go back to the index-base ETF that got you started. Beating the market is a noble goal, but there’s nothing wrong with simply matching the long-term returns of a healthy index like the S&P 500. With an average annual return of roughly 10% in the long run, you can double your money in seven years and triple it in 12.
— Anders Bylund
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Source: The Motley Fool