No, it’s not because I’m a Facebook hater. In fact, I think I’m one of the few Facebook users who actually really likes Facebook (yes, even the timeline). I wish I could say that I anticipated the company’s weakened growth forecast but it’s not that either. Nor is it because I necessarily think that the growing shift to mobile will turn Facebook into the next MySpace. The reason I didn’t buy Facebook stock is because I simply don’t buy any individual stocks. Period.
Let me explain. There are two basic philosophies when it comes to investing in stocks. The dominant philosophy in academia is that the stock market is essentially an efficient market, which basically means that no one can consistently beat it without luck or doing something that can send them to prison. There is some evidence of this since numerous studies have shown that the market consistently beats the vast majority of mutual fund managers. If that’s true, picking individual stocks is at best a waste of time (unless you’re lucky) and at worst can lead to the loss of a good portion of your savings if you’re not adequately diversified. That’s because an individual stock can go to zero and never come back. Instead, your best bet would be to simply buy a diversified portfolio of index funds and earn the market return.
The second philosophy is that it is possible to beat the market but it’s really, really hard. After all, if it was easy more mutual fund managers would be doing it. Keep in mind that these are people who have dedicated their lives to investing. Many have Ivy League MBAs in finance and finished at or near the top of their class. In addition, they have access to some of the most sophisticated software available, teams of research analysts that work for them, and lots of time to focus on picking stocks since it’s what they do for a living. The idea that I can outperform them in my spare time is laughable. (If you think you can, you might want to contemplate a career change. Considering how few fund managers are able to beat the market, you can be a top fund manager and make A LOT of money even when your fund loses money.)
That all being said, there are a couple of good reasons to own individual stocks. One is that if you have a large enough portfolio, it can be cheaper and more tax efficient than investing in mutual funds. You’d only pay a small commission when you buy and sell shares rather than an annual fund fee (although the fund fee may be less than the commissions if you’re investing small amounts) and you can better manage your tax liabilities.
The second reason is that some people get a lot of enjoyment out of following the market and picking stocks. If that sounds like you, go for it but think of it more as gambling (with much better odds) than investing. Set aside some “play money” that you’re willing to lose and buy just a few stocks that you really believe in. Who knows? You could pick the next Apple and make some money. But if you pick the next Facebook stock, at least your retirement won’t be in jeopardy.