Larry Swedroe argues that buying individual stocks is much riskier than we realize and he explains why this is. Even if you disagree, Larry makes points in this article that are worth thinking about. If you are making the mistake of not being adequately diversified in your stock holdings, this article may help you change your ways. ~ Ilene
Swedroe: Why Buy Individual Stocks?
If the dispersion of individual stock returns did in fact resemble a bell curve, then half of stocks would have returns above the mean and half would have returns that fall below the mean.
As you have seen from the literature, this isn’t the case. The explanation is that, while your profits are unlimited, you can only lose 100 percent of your investment. Thus, a few big winners (such as Google) cause the mean (or average) return to be above the median result. Consequently, there are more stocks that have below “average” returns than there are stocks with above “average” returns.
Investors make mistakes when they take idiosyncratic, diversifiable and uncompensated risks. They do so because they are overconfident in their skills; they overestimate the worth of their information; they confuse the familiar with the safe; they have the illusion of being in control; they don’t understand how many individual stocks are needed to effectively reduce diversifiable risks; and they don’t comprehend the difference between compensated and uncompensated risks (basically that some risks are uncompensated because they are diversifiable).
Full article: Swedroe: Why Buy Individual Stocks? | ETF.com.
Larry Swedroe is the director of research for the BAM Alliance, a community with over 150 independent registered investment advisors.
Picture via Pixabay.
