Why I Pick Stocks: Choosing Individual Stocks Over Mutual Funds

by Guest Blogger on 2009-04-2824

The following guest post is brought to us by Manshu from OneMint. Please check out his site and his RSS feed if you haven’t already!

I’ve chosen to pick individual stocks and have decided to invest in commodities as well. Also, rather than investing in GLD, I have opted to buy gold coins on my own. Rather than buying an infrastructure fund, I’ve purchased the stocks of steel mining companies myself.

Why I Pick Stocks Rather Than Invest In Mutual Funds

The conventional wisdom recommends that the average investor should go for the diversified approach and invest in mutual funds; this allows the investor to manage their risk and spread it across many stocks and asset classes. But I prefer a different approach to investing and creating a diversified portfolio, which I explain below.

I’m a stock picker, and here’s why. I like to pick stocks because I prefer to be able to manage my own stocks and know exactly where my money is invested. I don’t feel comfortable about buying mutual funds or ETFs because I don’t have any control over what the fund manager may do and which companies he or she will buy at any given time. It’s like being one level away from my investments.

pick stocks, individual stocks, dart board
Image by Bits of Truth

So as you can expect, I have never considered looking into a fund of funds because with such financial vehicles, not only would I worry about what the fund manager would do, but I’d also have to keep tabs on what his or her fund manager would do. Let’s look at how this works: if I buy a fund for the purpose of outsourcing the job of stock picking to an expert, and the fund manager of this aggregate fund does the same thing and simply buys other funds to participate in his portfolio, then what would I be paying him to do?

I’m also not keen about buying a fund of funds that invests in futures contracts. Because then, on top of worrying about my fund manager, plus the fund manager of my fund manager (it gets confusing) — I also have to keep on top of the underlying assets upon which the futures contracts are based. Unfortunately, I am about three levels away from my investments this way.

How I Choose Individual Stocks

I’m one of those investors who bases my investing decisions on how much I trust a financial institution or a particular company. One of the main factors that influences my investing decisions is what I call the “will this guy screw me” factor (pardon the french). I look at the track record of the management of a particular company and try to determine how much damage they could potentially do to my investments, whether it be through their incompetence or their dishonesty.

This is a purely qualitative and subjective measure, and is based on what I know about the management through its history and actions. If they don’t pass this criterion or if the management doesn’t have enough history, then I pass on the stock. Applying this criterion and analysis upon a fund of funds is almost impossible, and I believe that this is pretty much difficult to do for regular mutual funds as well, apart from a few established companies.

Then there is the issue of complexity. Looking at a steel company and understanding how they are going to make money is far simpler than looking at a fund that invests in numerous asset classes such as T-bills, futures, options, SWAPS, ETFs, mutual funds, commodities, stocks etc. and deciding how they are going to make money.

If you read a prospectus of a fund and you can’t figure out how they are making their money, then you are essentially putting your trust in the fund manager. That makes it all the more important for your fund manager to pass the “I won’t screw you” test.

For me, I’m most comfortable with picking my own stocks and staying really close to my investments. I make it a point to know where exactly my money is going and to understand what it is I’m buying. In order to sleep at night, I prefer to control and select my own investments, placing the full responsibility of managing these investments upon my own shoulders. So far it’s worked out for me.

Copyright © 2009 The Digerati Life. All Rights Reserved.

{ 24 comments… read them below or add one }

the weakonomist April 28, 2009 at 7:33 pm

This is an interesting perspective, and I thank you for keeping it all about you. I’ve read other posts like this where this idea is shoved down throats in a manner of “why would you PAY someone to pick stocks for you?”. This argument is so easily countered that I’ve stopped doing it when I see it.

For those of you that haven’t seen this before, paying someone to pick stocks for you in a mutual fund is the same as paying someone to change your oil, let the waist out in your pants, or even clean your house. You either don’t know how to do it well yourself, or it isn’t worth your time.

Also, you pay fund of fund managers to properly determine asset allocation again for convenience or you trust them to do a better job than you would.

But I digress and apologize for that. Manshu here kept the conversation to the self, and for that I am thankful. Be sure to check out onemint.com, it is a great site.

Mikael @ Retire Rich April 29, 2009 at 12:35 am

Great post Manshu! I suspect that you’re not just looking at the risk of management fuckups but also on whether the company will actually turn out to be a good investment, right? Would you care to share what aspects you think is important?

Tracie April 29, 2009 at 12:57 am

Have never been comfortable choosing stocks but am learning. I want to know where my money is going and not just seeing a report that I don’t understand without having to call and question.

Writer's Coin April 29, 2009 at 3:48 am

How did you do in 2008? I’m assuming it was as bad as the rest of us….if now worse.

Rob Bennett April 29, 2009 at 5:06 am

I personally love indexing. But I also think that its benefits have been wildly overstated. I think the point being made in this blog entry is an important one.

Investing is about taking on risk and being rewarded for doing so. Indexing has been marketed as a virtually risk-free way to invest. It is often described as better than all alternative approaches. It is not necessarily better. It is different. For some of us, it is better. For some of us, it is worse. It depends.

What it depends on is how we are positioned in the taking-on-risk question. For some of us, the biggest risk is that we don’t know what we are doing and don’t care to learn. For some of us, the biggest risk is that we cannot admit it when we are wrong. For some of us, the biggest risk is that we cannot afford to take losses. There are all sorts of possibilities.

Manshu has examined himself and determined that “this is the best way for me to go about taking risk — I need to see such and such to feel confident about an investment.” I think that is precisely the right way to go about risk assessment. I think that approach is right on.

Rob

OStanley April 29, 2009 at 6:22 am

You should only invest in the manner that you are good at. If you are good at picking stocks then pick stocks. Some people lose lots of money picking stocks but do very well with mutual funds. Investors need to develop their own style of making money and follow what works for them.

Sherin April 29, 2009 at 6:26 am

SVB, I have read the article and agree with the part of investing individual stocks and managing our own portfolio. I also intend to say that any person who have goodunderstanding on how to invest, should go for investing directly than hand over money to any mutual fund managers.

I have doubt about the success on your interested steel companies stocks. It is clear, such industry known as sick commodity business type, in the context of Warren Buffett advices on selecting a business to invest. Steel companies generally don’t have any type of monopoly with any products and always forcing to compromise the product price to compete with its number of competitors. It may lead them to lose or debt and there will not be any value for investor money.

In my personal biography of investing, I have mentioned my succeeded criteria’s of valuating and investing on companies. I hope adding the link will helpful for readers as well.. (yes, you can remove the link if it is not suitable here or I am violating the rules of comments. ).

Here is the link: http://www.investinternals.com/2009/04/personal-biography-on-investing-2.html

I strongly feel my selection criteria’s by reading Buffett , Ben Graham, Philip Fisher investment styles and practices, certainly help an investor to select right stocks, once if he required to invest personally on stocks and intent to manage his own stock portfolio.

Todd @ The Personal Finance Playbook April 29, 2009 at 8:04 am

I enjoy picking stocks, too. Almost all of our investments are in index funds, though. We have a portfolio of about ten individual stocks that I manage, because I enjoy the experience. The problem is, unless you’re already working in portfolio mgmt or as an analyst, I don’t think there’s enough to keep up with the ebbs and flows of the market. I take a value approach, and it’s still hard to find time between my family, job and blog. Anyway, best of luck to you managing your portfolio.

Mel April 29, 2009 at 9:12 am

I was a top-ranked analyst on Wall Street and I (and the CEOs and CFOs) didn’t know which way a stock was going to go most of the time. There were times when only having knowledge of the history of the industry and knowing the managements personally helped.

The point is, that it is very difficult for anyone to pick stocks, let alone an individual with no resources, connections, training, or industry history. So be very careful. Your comfort level and enjoyment of picking stocks should be the main reason, not beating the market, so you shouldn’t take too much risk in this part of your portfolio.

Manshu April 29, 2009 at 7:42 pm

@Mikael — One of my friends used to work in a leather export company and he kept complaining about the long hours and how he had to travel extra because the company bought cheap land to set up a factory about 10 miles further away from the current factory. I liked my friend’s misery 🙂 and bought the stock after a little more research. That worked out well. Another time, an Indian pharma company said that they are going to move away from generics and get into core research and I thought that this is a good idea, I bought that, but the company could never break ground and I lost money on that. Once, I visited an aunt in a hospital and saw that all the wards were full, place was really neat, staff helpful, did a little more research and bought into that — that worked out well. So, the triggers are all different , but generally stem from some first hand experience.

@Writer’s Coin — You are right, the stocks that I continued to hold on to, performed as badly as the rest of the market.

Thank you all for your comments and thanks to SVB for letting me guest post on her great site.

Lots April 29, 2009 at 8:51 pm

I use that same approach myself. For example, I bought WFC stock because I used to work there and understood the retail/branch side of the business. The “mostly” excellent service and “mostly” competent employees was something I felt comfortable in.

It’s also helped me stay away from certain stocks. For example, WAMU had a branch right next to the WFC I worked at, and not only were they unprofessional (slacks and polo shirts sitting on chairs compared to our suits standing up all day…I envied that then), it also took me over an hour to set up a free checking account…and the banker I was with couldn’t speak decent English.

Needless to say, WFC is holding up pretty well, and WAMU has disappeared off the face of this earth.

MoneyEnergy April 30, 2009 at 12:04 am

I’m a stock picker too (I use ETFs, though, for what I can’t easily get as stocks). It’s good to hear from someone else who’s not stuck on the mutual fund orthodoxy. Like you said, I like to know where my money is exactly going. I also like doing the research required for it. I don’t think I can say yet whether I’m ultimately “good” at it – I haven’t made too many major mistakes yet, which could also be a bad thing. I’ve probably overpaid on commission fees so far, though. Am correcting that going ahead.

eMoneyLog April 30, 2009 at 6:55 am

It is extremely risky to select individual stocks… index funds are still better for most investors…

Silicon Valley Blogger April 30, 2009 at 7:47 am

I agree, eMoneyLog. We talk about indexing all the time here, but this post was a justification one person makes for picking stocks, as he applies it to his own situation. It’s very interesting to see the thought process of other investors; I also don’t believe that investing can necessarily be approached one way. After all, stock picking and trading MAY actually work well with some people, depending on how skilled and dedicated they are to it.

Mr. ToughMoneyLove May 2, 2009 at 10:19 pm

No offense, but there is nothing in this post that establishes a sound basis for you or anyone else becoming a “stock picker.” A collection of stocks is nothing more than a personalized mutual fund. Most professional fund managers – which you are not – cannot beat the performance of a monkey throwing darts at stock dart board. (Don’t believe me? Read Scott Burns’ article from this week). The bottom line is that you don’t know anything that the market in general does not.

Silicon Valley Blogger May 3, 2009 at 12:51 am

Mr. ToughMoneyLove,

I hear your argument loud and clear in my home actually (thanks to my spouse who wholeheartedly believes that the price is already built into the market). But I look upon this article as a very interesting contrarian view. I knew of a guy at my old job who was intelligent beyond belief and who took up day trading and stock picking as a hobby. And despite my misgivings that he would fall flat on his face at some point playing this way, he turned out to be pretty good at both activities. Of course, over the long term, we don’t know how things will turn out, but I wouldn’t put it past a small percentage of people to do reasonably well participating in activities considered “risky” for the average investor to do.

I’ve written countless posts discussing the issues involved with investing via trading, buying penny stocks or even individual stocks. But there are those who enjoy the process and who either develop strong skills playing the market this way or who eventually learn that it’s not for them.

I’d be interested to know how good Manshu’s track record is (and how long he’s been picking stocks).

Mupals May 14, 2009 at 7:15 am

@: Silicon Valley Blogger : I agree to an extent with your take, Can you share with us your performance before and after you started to pick stocks or a comparison of how your portfolio of index did vs your own selection of stocks.

Jason May 27, 2009 at 1:25 pm

I like to choose individual stocks based on the research I do for myself. With mutual funds there are far too many fees. I can scalp stock more easily.

Jerico July 5, 2009 at 8:22 am

Great post, I just subscribed to OneMints RSS feed, thank you for the great post and introducing OneMint.

jennismortal July 10, 2009 at 2:19 am

Thanks …nice post.Mutual funds provide a safer solution than individual stocks. Mutual funds offer low systematic investment amounts most people can afford. For $25/month, you can start saving in a mutual fund and reap the benefits of consistent returns.

Mr.Bill July 2, 2010 at 8:13 am

I thought that picture of the dartboard was a bowl of chip dip. I saw salsa in the middle and guac on the outside. Funny stuff!

Eric Conklin September 30, 2010 at 10:15 am

I totally agree with what you’re saying. People don’t realize just how much work goes into window dressing the average mutual fund.

Unless you REALLY know who you are buying from and everything that has ever been in a fund and why, you are better off picking stocks and funds on your own.

After all, most mutual funds don’t even outperform the market. It’s sad, really, but a diversified group of stocks chosen by someone else is about as great if not worse than just buying up the SPY or QQQQ

Minnie June 25, 2012 at 12:14 pm

I’ll tell you why I don’t pick stocks — because I’m lousy at it.

And sure, there are those with the golden touch — I knew this guy ages ago who went on to become one of these top wall street analysts several years running. Unfortunately, we’re no longer in contact, so I can’t ask for tips! Looking at him, I’m not sure how he does it. I won’t pretend to know how to make it work consistently.

Joey June 25, 2012 at 1:14 pm

I avoid stock picking myself: I’m often confused by the opposing views. What else is the market but a conglomeration of mixed signals that eventually point to some direction. Thus, I let the market do the job for me via indexes, or have experts do it for me via mutual funds. Since I’m not a very good technical analyst, but rather an intuitive, “lazy” investor, I’m not going to guess. I’ll only put in my money into a stock if it’s in an industry I’m truly comfortable with.

Leave a Comment