By Liam Pleven
Investors could be easily dazzled by the current stars of the
stock market and tempted to ditch boring index funds for a piece of
the action.
Twitter shares have gained 41% this year through Thursday. Apple
is up 14%, after rising for six years in a row. Shares of Kraft
Foods Group have shot up 45% since March 24, the day before a
proposed merger with H.J. Heinz was announced.
Not bad in a year when the S&P 500 is up less than 1%.
But consider this sobering fact: Even when the market is up,
many stocks drop. Last year, when the S&P was up 11%, 125
stocks in the index fell, says S&P Dow Jones Indices.
Owning individual stocks is risky. Most investors are better off
buying low-cost funds that hold broad buckets of stocks, because
consistently picking winners is difficult, if not impossible--and
picking losers can be costly.
If you're still inclined to roll the dice, consider these
tips:
-- Invest only a small slice of your portfolio in individual
stocks.
-- Keep trading to a minimum, because the cost of buying and
selling makes it even harder to come out ahead.
-- Be especially cautious about loading up on shares of the
company you work for, because a major problem could threaten its
share price and your job at the same time.
-- Think hard before wagering an amount that, if it evaporated,
would compromise your lifestyle or make it difficult to reach your
financial goals.
According to federal survey data, 14% of U.S. households owned
individual stocks outside of retirement accounts in 2013, the most
recent year for which figures are available. In those households,
stocks typically account for 13% of all financial assets outside of
retirement accounts, according to an analysis of the data by the
Investment Company Institute, a trade group.
Investors hold individual stocks for many reasons, even if they
put much of their money in broad, low-cost funds. They may have a
hunch, and spare cash to test it. They may get a discount on shares
of their employer. They may inherit stock. They may like the thrill
of the game.
But don't forget the game can end badly, says Christopher Jones,
chief investment officer at Financial Engines, in Sunnyvale,
Calif., which is hired by firms to help employees allocate assets
in 401(k) plans.
Four publicly traded companies that had more than $1 billion in
assets have sought bankruptcy protection this year, according to
data from BankruptCompanyNews.com, which tracks such filings.
Allan Roth, a financial adviser at Wealth Logic in Colorado
Springs, Colo., says most investors shouldn't have more than 5% of
their portfolio in individual stocks. That means 5% in total, he
stresses--not 5% each in a small handful of stocks. Other investors
may put the percentage higher or lower, depending on factors such
as overall wealth, living expenses and tax planning.
There is the risk of losing money, of course, but good fortune
also can bring headaches. What started out as a small slice of your
portfolio may balloon into something much bigger, as some longtime
Apple investors have found.
One risk is that you come to count on investment gains to
maintain your standard of living. If you need the money, you should
consider selling all or most of the appreciated stock to lock in
those gains, says William Bernstein, who is co-principal of
Efficient Frontier Advisors in Eastford, Conn.
If the gains aren't funding your dreams, you could hold on to
the stock. Just be sure you won't be filled with remorse if it
subsequently tanks.
Similarly, investors who inherit stock should consider selling
it to diversify, Mr. Roth says. If that is difficult because the
inherited shares came from someone with whom you had a strong
emotional bond, consider selling half of it, he says.
"If it does poorly, you can pat yourself on the back for selling
half of it," says Mr. Roth. "If it does well, you can pat yourself
on the back for keeping half of it."
William Green III, who is 56 years old and lives in Blythewood,
S.C., says he and his wife gradually sold off and donated to
charity some shares in Exxon Mobil she got from a relative.
At one point, Exxon shares comprised nearly 20% of the couple's
portfolio, which Mr. Green says made him "nervous." Now, the stake
amounts to less than 10%.
"You do not want to be in one single stock, even if it's the
best company in the world," says Mr. Green, who is a psychiatrist.
Reducing the holdings, he says, helped him sleep better at
night.
Email: Liam.Pleven@wsj.com
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