I like investing in individual stocks. It’s fun, it’s interesting, I learn a lot doing it and most of all, it helps provide for my family and my future retirement. Now don’t get me wrong, there’s nothing wrong with just investing in a low-cost index fund and most people already do to some degree if they don’t know it. Specifically, most people invest in their company’s 401k plan and generally there are target date funds that have a rather sizable allocation to some low-cost index fund. Skeptical? Check out Vanguard’s Target Retirement 2050 Fund ($VFIFX). They allocate 54% to the Vanguard Total Stock Market Index Fund Investor Shares ($VTSMX) which is a perfectly fine fund.
In fact, most people, including you and me, have a decent stake in Tesla, whether or not you believe in the company or not. In that particular retirement fund, Tesla makes up approximately 1.4% of the entire fund largely because of the sheer size of the company and its weighting in the index. So if you’re an Elon Musk fan, that’s probably great news, if you’re an Elon Musk hater, well, sorry I told you! I digress.
So, when it comes to investing in stocks, these are the 5 primary reasons as to why I invest in individual stocks and why you should consider dabbling if you haven’t already:
1. Individual Stocks Can Beat the Market
I know, I know. There are studies after studies that show that most people can’t beat the market, especially the professionals. Let me emphasize those last 3 words, especially the professionals. Generally the professionals, those active managers, can’t beat the market because they have benchmarks that they need to track and adhere to, they have high management expenses that the fund needs to overcome, they don’t want to get it wrong so they often follow trends, they need to deal with distributions, etc. etc.
I’m not an active manager though. I generally invest in stocks with a buy and hold strategy with no defined time horizon. I also don’t need to diversify too broadly to mitigate “risk” and most of all, I can invest in solely in sectors that I know really well.
Also, when it comes to individual stocks, the S&P 500 which is the traditional benchmark most index funds track to, has 500 of the biggest companies traded on American exchanges and while the index will spit out a return of 7-9% on average, the actual individual performances of those 500 stocks vary GREATLY.
Let’s take a look at the YTD results of one of the most popular index ETFs: SPDR S&P 500 ETF Trust ($SPY). So this ETF passively tracks the S&P 500 and YTD has returned 5.02%. If you jump into their individual holdings, it’s a much different story:
As of the end of February 12, 2021:
1. Apple ($AAPL) is their biggest holding and has returned less than HALF of the 5.02%, coming in at 2.17%
2. Microsoft ($MSFT) on the other hand has doubled the S&P 500 return, coming in at 10.15%
3. Tesla, one of the most polarizing large cap stocks is up a whopping 15.65%, so over TRIPLE the S&P 500’s YTD return
4. Nvidia ($NVDA) and Etsy ($ETSY) are two stocks that make up a sizable chunk of my portfolio are up 14.6% and 31.45% respectively!
5. PepsiCo ($PEP) & Coca-Cola ($KO) are down 9.73% and 7.27% respectively so around 12-15% off from the index’s YTD total
Here’s a graph that shows the percentage of companies in relation to the benchmark that performed greater than or less than 1% of the benchmark as well as the percentage of companies that performed within 1% of the benchmark.
As you can see, more than 90% (48.5% + 44.2%) of companies in the index have returns that are over or under 1% of the benchmark.
Also, what’s really interesting is that nearly 50% of the companies in this index have performed worse than the index but another 44% of companies have performed significantly better than the index.
I think that’s pretty interesting because it shows that it’s almost the probability of the flip of a coin to select a company in this index that will beat the benchmark, now throw in some actual research, and I think the odds aren’t too bad if you invest in great companies.
2. Compounding Returns is a Beautiful Thing
Albert Einstein famously said, ““Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.”
When you invest in a great company that is growing exponentially and compounding your investment year over year, you will achieve stock returns that are out of this world and that can create life-changing returns.
Take for example Netflix ($NFLX). Netflix is one of the best performing stocks in the past 10 years and for good reason. They first took out Blockbuster with their DVD mail-in service and then pivoted to streaming which has been a game changer especially during this pandemic. They’ve been able to grow their annual revenue by 20%+ 9 out of the last 10 years and have seen their stock grow at a 35.3% annualized rate since 2011.
Here’s what Netflix’s annual revenue looked like in the past 10 years:
So even in 2011, Netflix was a pretty sizable company, pulling in $3.2 billion in annual revenue but with 10 years of double digit returns, they grew to nearly $25 billion by the end of 2020.
If you had invested in Netflix on January 1, 2011 and held through December 31, 2020 vs. doing the same for the S&P 500, here’s a few different scenarios:
Holding a stock for 10-years definitely takes patience and a strong will, especially given some of the volatility Netflix’s stock has had over the years, but for investors who believed in the original thesis and held firm, this is a stock that has generated life-changing returns for many. My first investment in Netflix was in 2015 and even that investment has nearly 5x’d since my initial purchase.
You may wonder, “well, how many Netflix’s are there?”
Well, you’re probably right that over a 10-year span, there aren’t many stocks that have increased their share price by 21x, but I will say that in the past 5 years, I have had several stocks that have grown over 10x: Shopify ($SHOP), Etsy ($ETSY), and Nvidia ($NVDA) to name a few and a good number that have doubled, tripled or quadrupled. It takes some research and 💎🙌 through the dips, but it’s not as hard as you think.
3. Researching New Stocks & Businesses is Interesting & Rewarding
I personally find a lot of pleasure researching stocks and learning about new businesses and business models. I will 100% say that researching stocks and doing the necessary due diligence has also made me become better at my job since you learn a lot about functions that are related or similar to your job. For example, I learned a lot about brand marketing and marketing investments by doing research on Stitch Fix ($SFIX). They actually had launched a brand campaign around the same time my former company Sprout Social was planning to launch their own, and I was able to get some interesting insights from Stitch Fix’s brand campaign that helped me with Sprout Social’s brand campaign.
Fiverr ($FVRR) is a two-sided Marketplace similar to my current company’s business model and I have definitely pulled from their playbook given that they are a significantly bigger business and why try to reinvent the wheel?
Researching stocks have also made me adopt and embrace new products and platforms. I was an “early investor” in Zoom Video Communications ($ZM) and when the pandemic started, I bought a professional license to support the business and to use it for my personal day-to-day communication with friends and family. I also started using Etsy for various purchases and even utilized their affiliate program as a way to expand my affiliate marketing website.
Finally, it is incredibly rewarding to do a lot of due diligence on a stock, make your purchase and to see your due diligence pay off (pun intended)!
4. Investing is Competitive & Fun
There’s always a benchmark or something for you to track how your individual investments are doing against the index. I always do a month-end and annual performance check to see how I’m doing versus the index and it’s fun and rewarding to beat the index. Like all competitive things too, you try to get better by learning and “practicing” your art by reading and doing it more and more. In the past few years, I’ve learned how to read company financials, how to read an S-1 for companies planning to IPO, how to trade options, and many other things that I think have helped me to become a more savvy and sophisticated investor.
In addition, I feel like I’ve become a better investor because of my competitive nature and desire to always outperform the markets.
Here’s my annualized returns over the past 5 years:
With the exception of 2016, I’ve been able to beat the S&P 500 index quite handedly and I definitely have learned a lot in the past 5+ years.
5. It’s a Humbling Process
While I’ve had a good amount of success investing in the stock market, it’s always still a humbling process. I continue to recognize how emotional and impatient I can be on certain investments. For example this year despite a solid YTD return so far, I made several major blunders, one being in GameStop. At the peak, I was up nearly 6-figures on my GameStop investment and I chose to hold even after all the panic selling which resulted in a gigantic swing. I ended up netting out a slight profit, but ultimately was a loser when you factor in all the other meme stocks.
Another example, when the pandemic first hit back in late March, my portfolio of individual stocks at the trough was down 20% and boy, that was a humbling experience since 2019 was such a huge year. Also, let’s be honest, I made a lot of panic sells during that heightened period of volatility as did many people which resulted in some huge opportunity costs down the road.
Back in 2018, I saw a 70%+ return drop to 8.3% by the end of the year. It was pretty depressing and shocking as I saw my portfolio bleed everyday for months. I again made a ton of bad decisions that resulted in some massive losses in upside.
I believe these humbling experiences enable me to become a better investor and to also realize that I am still a very young investor comparatively which means there is still a lot of room for growth.
At the end of the day, these are just a few of the many reasons why I choose to invest in individual stocks. No one should feel compelled to allocate a large chunk of their portfolio to individual stocks given what this article has written. Truth be told, it took a few years for me to slowly shift my brokerage & Roth IRA accounts to 100% individual stocks. I do believe that a slow measured approach to test your appetite for volatility and simply to get started is fine. Individual stocks, as fun as they are, are often incredibly more volatile than index funds and it takes some nerves of steel sometimes when an earnings report is poorly received.
If you’re interested in exploring some individual stocks, I wrote an article earlier in the year about some stocks to watch in 2021. By no means are these recommendations, but simply stocks that I am personally very bullish on and something you may want to consider doing some due diligence on.