1. Individual Stocks and Retirement Portfolios

This is part one of seven in my attempt to explain how you should invest in your retirement portfolio.  Click here for the introduction.

Should I own individual stocks in my retirement account?  In the Fall of 2007, I had just come off a bitterly disappointing fantasy baseball season.  It was a season where I spent about 30 minutes a day researching stats and adjusting my roster.  Every day I would look at each player to see what his batting average was against the opposing pitcher, if he was on a hot streak and or even if he was playing a day game or night game (some players hit better in the day).  So when I came in third place, I felt like I had nothing to show for all the time and research that I had spent that season.

Coincidentally, that semester in school I was introduced to the stock market for the first time and became fascinated with the idea of making money in stocks.  I thought to myself, “If I spend as much time as I do on fantasy baseball on researching stocks, I might be able to actually make money instead of wasting my time looking at baseball stats.”  And so I began investing in a discretionary (non-retirement) portfolio.

As of today, my portfolio’s value has declined about 4 percent from its original value in 2008.  This is not terrible considering many portfolios lost 1/3 of their value during the mortgage crisis that happened to occur at the same time, but it is also nothing to brag about.  I still keep some money in this discretionary portfolio, but when I asked myself the question “Where should I put my retirement money?” I vowed to never own any individual stocks in my retirement portfolio.  Here are the three questions I asked myself that got me to that conclusion.

How much time do I want to spend on my retirement account every week?  Believe it or not one of the best books I read on individual stock investing was Real Money by Jim Cramer.  It was great at teaching the basics of how to analyze stocks and time the market by explaining things like price to earnings ratios and sector rotation.  One of the most important lessons I learned from Cramer was that owning stocks was not about “buy and hold” but “buy and homework” – as he is famous for saying.  He recommends that you do one hour of research per week for every stock you own, and that you need to own at least 5 stocks to have a diversified portfolio.  That is five hours more than I want to spend thinking about my retirement account every week.

If I spend the time, will it be enjoyable or stressful?  All right, let’s say I did have the time and inclination to spend at least 5 hours a week doing research.  That means that I’d be checking my stocks’ value once a day on the internet.  I would be straining my ear if I heard something on the radio about the stock market and thinking of what it might mean for my retirement.  Instead of flipping channels right past CNN I might actually want to hear what the talking heads are saying about the Federal Reserve and interest rates – and still have no idea if I should buy or sell some of my shares.  I know for a fact that there will be surges of joy when my portfolio goes up 2% in value one day, and then instant depression if the portfolio’s value drops. To me it just sounds like stress.  Especially when my ability to retire is on the line.

How likely am I to get better returns than everyone else?  Just for fun, I asked myself, what if I did have the time, and I didn’t mind the stress.  What makes me think – as an individual investor researching 5 hours a week – that I am going to see greater returns than a MBA that does this for a living?   Sure, there are always going to be a few people that made the right call and hit it big.  And I will always have some friends telling me how good the market’s been to them (though I know they are probably lying).  The fact of the matter is that the market is a zero sum game.  The winners and losers must balance out.  How can I be so sure that I’ll be on the winning side?  As I later learned (and present in part 2), all the research indicates that underperformance is a much more likely scenario.

I’m not trying to say that investing in individual stocks is always a bad idea.  I am saying it’s a bad idea for a retirement portfolio.  Its one thing if you make the wrong call in your discretionary portfolio and have to buy a 40 inch TV instead of the 60 inch 3D HDTV you’ve been saving for.   But what if you make the wrong call in your retirement portfolio?  The fact is, because the retirement nest egg is so important to your future security, buying and selling decisions have extra stress and extra importance.   Having that extra stress for returns that aren’t even likely to beat the market hardly seemed worth it.  Especially when I have to spend at least 5 hours a week.  So If I don’t want to invest in individual stocks myself, where should I put my money?

To continue reading, follow the link to Part 2 – The Case for Index Investing.