How Owning Individual Stocks Can Destroy Your Portfolio

Wanderer
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A reader asked us the other day “Why are you so against owning individual stocks? If I want to directly own a few companies I follow alongside a balanced, diversified index ETF-based portfolio, what’s wrong with that?”

This is actually a really important question, because it’s fairly common for people to set aside a portion of their portfolio and actively trade with it. Maybe it scratches their itch to “do” something, or maybe they think it’s fun to day-trade. I don’t personally find it fun, but some do, and I admit that while index investing is stastically the best and safest way for ordinary folks to make money in the stock market, it isn’t exactly glamorous.

However, when I find out someone’s doing this, I always recommend they stop. It’s not because I don’t believe in their ability to day-trade, it’s actually because it’s incredibly easy for a bad stock pick to destroy the rest of your portfolio in ways that aren’t immediately obvious.

The best way to demonstrate this is with an example.

Our Amateur Day Trader Portfolio

Let’s imagine one of these amateur day traders. They’ve read our Investment Workshop and are mostly convinced that index investing is for them. They get the idea of buying broad-based ETFs, holding them in a certain asset allocation, and then rebalancing when their allocation gets out of whack. Buy low, sell high! Seems pretty simple.

BUT, our trader also just watched Wolf of Wall Street, and that looks pretty fun! Buying, selling, messing around with options. Plus all the cocaine and hookers you could want! Awesome!

So our trader figures, you know what? What if 90% of my portfolio is held in boring but safe index funds, and 10% of my portfolio I get to do whatever I want with. If I turn out to be a wildly successful day trader, then I can do more of that in the future, but if I completely screw it up at least the damage is limited to 10% of my portfolio.

Seems reasonable, right? Well, let’s see what happens in practice.

OK so let’s create a simple portfolio. I’ll make up an index ETF called IDX which represents an index ETF. And then we’ll say that our trader starts off with a stock that he really likes, called STK.

Our trader has $100k to invest, and both IDX and STK are currently trading at $100 a pop, so our trader buys 900 of IDX and 100 of STK to create his initial portfolio.

VTI Units Stock Units VTI Price Stock Price Total Mkt Value
900.0 100.0 $100.00 $100.00 $100,000.00

Super. Now let’s say our company STK misses a quarterly earnings forecast and their stock price takes a major hit, down to $50. Now that sounds bad, but remember STK only represents a 10% allocation, so our overall portfolio isn’t hit too badly, dropping in value to $95,000. Our day trader isn’t too worried, because he understands that price dips are just buying opportunities, so they rebalance their portfolio, selling a few units of IDX to raise cash and then investing the proceeds into buying more units of STK until their original asset allocation of 90%/10% has been restored.

VTI Units Stock Units VTI Price Stock Price Total Mkt Value
900.0 100.0 $100.00 $100.00 $100,000.00
855.0 190.0 $100.00 $50.00 $95,000.00

Then the CEO of STK gets caught having sex with a marmot or something, and the tabloids have a field day. STK’s price continues to plummet down to $25. Our investor dutifully rebalances once again, confident that they’re doing the right thing in buying into the dip.

VTI Units Stock Units VTI Price Stock Price Total Mkt Value
900.0 100.0 $100.00 $100.00 $100,000.00
855.0 190.0 $100.00 $50.00 $95,000.00
812.3 361.0 $100.00 $25.00 $90,250.00

Then it turns out that the marmot had COVID, so now the CEO has COVID. STK’s price continues to fall, now to $10.

VTI Units Stock Units VTI Price Stock Price Total Mkt Value
900.0 100.0 $100.00 $100.00 $100,000.00
855.0 190.0 $100.00 $50.00 $95,000.00
812.3 361.0 $100.00 $25.00 $90,250.00
763.5 848.4 $100.00 $10.00 $84,835.00

Now our investor is starting to see the signs of something horribly wrong. His total portfolio is now worth $84,835. How is that possible? He limited his exposure to STK to only 10% of his portfolio, so how is it possible that the portfolio has now lost more than 10% of its value?

But STK’s fall isn’t over yet. It continues to plummet all the way down to $1…

VTI Units Stock Units VTI Price Stock Price Total Mkt Value
900.0 100.0 $100.00 $100.00 $100,000.00
855.0 190.0 $100.00 $50.00 $95,000.00
812.3 361.0 $100.00 $25.00 $90,250.00
763.5 848.4 $100.00 $10.00 $84,835.00
755.9 933.2 $100.00 $9.00 $83,986.65
747.5 1038.2 $100.00 $8.00 $83,053.47
738.1 1171.6 $100.00 $7.00 $82,015.30
727.6 1347.4 $100.00 $6.00 $80,843.65
715.5 1589.9 $100.00 $5.00 $79,496.26
701.2 1947.7 $100.00 $4.00 $77,906.33
683.6 2532.0 $100.00 $3.00 $75,958.67
660.8 3671.3 $100.00 $2.00 $73,426.72
627.8 6975.5 $100.00 $1.00 $69,755.38

Then down to $0.10…

VTI Units Stock Units VTI Price Stock Price Total Mkt Value
900.0 100.0 $100.00 $100.00 $100,000.00
855.0 190.0 $100.00 $50.00 $95,000.00
812.3 361.0 $100.00 $25.00 $90,250.00
763.5 848.4 $100.00 $10.00 $84,835.00
755.9 933.2 $100.00 $9.00 $83,986.65
747.5 1038.2 $100.00 $8.00 $83,053.47
738.1 1171.6 $100.00 $7.00 $82,015.30
727.6 1347.4 $100.00 $6.00 $80,843.65
715.5 1589.9 $100.00 $5.00 $79,496.26
701.2 1947.7 $100.00 $4.00 $77,906.33
683.6 2532.0 $100.00 $3.00 $75,958.67
660.8 3671.3 $100.00 $2.00 $73,426.72
627.8 6975.5 $100.00 $1.00 $69,755.38
621.5 7673.1 $100.00 $0.90 $69,057.83
614.6 8536.3 $100.00 $0.80 $68,290.52
606.9 9633.8 $100.00 $0.70 $67,436.89
598.3 11078.9 $100.00 $0.60 $66,473.50
588.3 13073.1 $100.00 $0.50 $65,365.61
576.5 16014.6 $100.00 $0.40 $64,058.30
562.1 20818.9 $100.00 $0.30 $62,456.84
543.4 30187.5 $100.00 $0.20 $60,374.95
516.2 57356.2 $100.00 $0.10 $57,356.20

Then all the way down to a single penny, before finally declaring bankruptcy.

VTI Units Stock Units VTI Price Stock Price Total Mkt Value
900.0 100.0 $100.00 $100.00 $100,000.00
855.0 190.0 $100.00 $50.00 $95,000.00
812.3 361.0 $100.00 $25.00 $90,250.00
763.5 848.4 $100.00 $10.00 $84,835.00
755.9 933.2 $100.00 $9.00 $83,986.65
747.5 1038.2 $100.00 $8.00 $83,053.47
738.1 1171.6 $100.00 $7.00 $82,015.30
727.6 1347.4 $100.00 $6.00 $80,843.65
715.5 1589.9 $100.00 $5.00 $79,496.26
701.2 1947.7 $100.00 $4.00 $77,906.33
683.6 2532.0 $100.00 $3.00 $75,958.67
660.8 3671.3 $100.00 $2.00 $73,426.72
627.8 6975.5 $100.00 $1.00 $69,755.38
621.5 7673.1 $100.00 $0.90 $69,057.83
614.6 8536.3 $100.00 $0.80 $68,290.52
606.9 9633.8 $100.00 $0.70 $67,436.89
598.3 11078.9 $100.00 $0.60 $66,473.50
588.3 13073.1 $100.00 $0.50 $65,365.61
576.5 16014.6 $100.00 $0.40 $64,058.30
562.1 20818.9 $100.00 $0.30 $62,456.84
543.4 30187.5 $100.00 $0.20 $60,374.95
516.2 57356.2 $100.00 $0.10 $57,356.20
511.0 63091.8 $100.00 $0.09 $56,782.64
505.4 70189.6 $100.00 $0.08 $56,151.72
499.0 79214.0 $100.00 $0.07 $55,449.82
491.9 91096.1 $100.00 $0.06 $54,657.68
483.7 107493.4 $100.00 $0.05 $53,746.72
474.0 131679.5 $100.00 $0.04 $52,671.79
462.2 171183.3 $100.00 $0.03 $51,354.99
446.8 248215.8 $100.00 $0.02 $49,643.16
424.4 471610.0 $100.00 $0.01 $47,161.00

Our shell-shocked investor surveys the wreckage on his portfolio. Beginning with a $100,000 investment, by investing 10% in an individual stock and that stock going to $0 has somehow left him with a portfolio only worth $47,161, or a -53% drop! How did a stock pick only worth 10% of our starting portfolio result in more than half of his money going poof?

Rebalancing Doesn’t Work For Individual Stocks

Here’s why I never recommend our readers own individual stocks: By learning how to manage a balanced and diversified index portfolio, they might mistakenly believe the same techniques work for individual stocks.

They do not.

Let me repeat this for emphasis: Every technique we write about on this blog assumes you are buying index ETFs only. They do NOT work on individual stocks.

The reason for this is that the rebalancing technique we teach (and created a tool to help you perform) only works if it’s impossible for any of the assets to fall in price to $0. Index ETFs can’t fall to $0, since that would require every company in the index to go bankrupt at once.

If it’s possible for even one direct holding in your portfolio to fall all the way to $0, it acts as a black hole in your portfolio. Rebalancing would instruct you to continually sell your other holdings in order to shovel more and more money into the failing company. As that company’s stock price falls, you would end up buying more and more units of the failing company until its shares swamp your portfolio. And then when it finally gets delisted, everything you’ve invested into that company is gone.

But wait. Why does rebalancing work for index ETFs but not individual stocks? Don’t individual ETFs own individual stocks under the hood?

The reason is that the index ETFs are managing their stock holdings using a different technique than what we teach here. Index ETFs generally manage their holdings using a market-cap-weighting system (except the Dow, but the Dow’s weird. Don’t own the Dow). Basically, they take a look at each individual companies total market cap (which reflects the total value of the company), and then buy or sell those stocks so that they own more bigger companies and less smaller companies. They usually also have a cut-off point of market cap for a company’s inclusion in the index. The S&P 500, for example, tracks the largest 500 companies in the US.

This system is what gets rid of failing stocks for you behind the scenes. As a company falls in price, the index will automatically sell it so it owns less and less of it. And when that company falls underneath the index’s threshold, it gets sold off completely and booted from the index, though by the time that happens it’s such a small component of the index that the fund holder (you) will barely notice.

Index funds seem simple, but they’re actually deceptively sophisticated. The market-cap-weighting methodology that they use at the institutional level combined with the allocate-and-rebalance methodology that an investor does at the personal level is what makes this system we’ve created for our investment portfolios so safe. But that doesn’t mean you can take the strategies that you use at the personal level and apply it to individual stocks.

Is there a way to own Individual Stocks safely?

But is there a way to own individual stocks without them blowing up your portfolio? Yes, but you’re going to need a whole different methodology than the one we teach in the Investment Workshop.

The issue is that, as this example demonstrates, there’s no mechanism to remove a failing company from your holdings.

There are multiple ways to fix this. One is to copy the index funds and adopt a market-cap-weighting methodology, though calculating market cap isn’t always easy.

A simpler strategy exists that could work in avoiding the situation our hypothetical investor encountered. Again, I’m not recommending it since I don’t recommend owning individual stocks at all, but if you HAVE to…

Set a Stop-Loss Order

When you decide to own a stock, pick an exit price that if the stock falls below that value, you cut your losses and sell all of it. What price you pick is up to you. Too high and you might accidentally sell it during a temporary dip, but too low and more of your portfolio will get hurt before you get out.

Whatever exit price you pick, you can enforce it by setting a Stop-Loss order. A stop-loss order, as the name implies, is used to stop your losses on an individual stock. You pick a price below its current market value and you just leave the order active. If the price ever drops to below your “stop” price, the order triggers automatically and sells at that price, thus limiting the damage.

If our amateur stock picker had set a stop-loss order for, say, $25 for STK, here’s what would have happened as the stock price plummetted.

VTI Units Stock Units Cash VTI Price Stock Price Total Mkt Value
900.0 100.0 $0.0 $100.00 $100.00 $100,000.00
855.0 190.0 $0.0 $100.00 $50.00 $95,000.00
812.3 361.0 $0.0 $100.00 $25.00 $90,250.00
812.3 0.0 $9,025.0 $100.00 $10.00 $90,250.00
812.3 0.0 $9,025.0 $100.00 $9.00 $90,250.00
812.3 0.0 $9,025.0 $100.00 $8.00 $90,250.00
812.3 0.0 $9,025.0 $100.00 $7.00 $90,250.00
812.3 0.0 $9,025.0 $100.00 $6.00 $90,250.00
812.3 0.0 $9,025.0 $100.00 $5.00 $90,250.00
812.3 0.0 $9,025.0 $100.00 $4.00 $90,250.00
812.3 0.0 $9,025.0 $100.00 $3.00 $90,250.00
812.3 0.0 $9,025.0 $100.00 $2.00 $90,250.00
812.3 0.0 $9,025.0 $100.00 $1.00 $90,250.00
812.3 0.0 $9,025.0 $100.00 $0.90 $90,250.00
812.3 0.0 $9,025.0 $100.00 $0.80 $90,250.00
812.3 0.0 $9,025.0 $100.00 $0.70 $90,250.00
812.3 0.0 $9,025.0 $100.00 $0.60 $90,250.00
812.3 0.0 $9,025.0 $100.00 $0.50 $90,250.00
812.3 0.0 $9,025.0 $100.00 $0.40 $90,250.00
812.3 0.0 $9,025.0 $100.00 $0.30 $90,250.00
812.3 0.0 $9,025.0 $100.00 $0.20 $90,250.00
812.3 0.0 $9,025.0 $100.00 $0.10 $90,250.00

Once STK’s price dipped below $25, the stop-loss would have automatically triggered to sell the 361 units he had for $25. Then the damage would be done, with the continual drop in STK’s price no longer hurting him anymore.

And if STK’s price picks back up again, you can always re-acquire later, but having a stop-loss would prevent the catastrophic implosion that he saw earlier.

So that’s it! That’s why owning individual stocks in an indexed portfolio is incredibly dangerous. There are ways to mitigate the potential damage by using stop-loss orders, but again, the easiest and most effective way to safeguard your retirement portfolio is to not own individual stocks at all. Let the Index ETF managers deal with all that noise while you sail calmly towards FIRE.

 


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57 thoughts on “How Owning Individual Stocks Can Destroy Your Portfolio”

  1. I vividly recall the Apple/Nortel example from a post of yours some years ago on the same topic. Thanks to that, individual stock picks are for fun and games only and do not figure in any serious investment conversations I’m interested in having.

    I’ve got a little stock from my employer thanks to grants that have been vesting over a five-year period and an ESPP that provides nice buying opportunities. If everything were to be magically vested right now at current prices, that slice of the pie would be just over half a percent of our total invested assets. That works for me!

  2. I’ve still got an unnecessarily large amount of money in an individual stock, as a result of stock compensation over the years. But the only reason that is still true is because I can only sell so much each year without having to pay taxes (sitting at an average 300%+ gain). Fortunately, that company is printing money and is unlikely to go out of business in the next five to ten years (which is how long it will take to be fully divested). I wish I had sold the stock as soon as it vested (throughout my career) – the current batch hasn’t grown much more than my index funds have, and some previous employer stocks tanked while I was holding them.

  3. Uh, a stop loss at $25 from a purchase price of $100? That’s an extremely stupid way to set a stop loss. Buy high, sell low! Why ever set a stop loss after losing 75% of the value? I would set a stop loss in the money. Buy at $100, it goes up to $115 and I set a stop loss at $107. I would therefore lock in a profit no matter what. Even if the price is at your current purchase price of $100, I would set a stop loss at $90 or so to cut the bleeding if worst comes to worst. As the price goes up, I would automatically increase the stop loss so that I’m eventually in the money.

    For those who would wait till they have a 75% loss, they don’t know what they’re doing and will lose their money eventually either way. And yes, I recognize there are plenty of these fools out there.

    1. What an actual fool you are. First, if you can trade successfully and consistently for years (not months or weeks), you would not be wasting your time here. Second, you completely miss the big picture. The writer can give $25-figure, or $50-figure, or $75-figure, but that’s not the point. The point is to sell loser, much like you.

      1. why so harsh?

        thousands r successful in trading. Emotionally, we r wired not do to it well and the average bloke will not ‘sell high and buy low’. Fear is a greater emotion than greed

  4. I believe most investors would behave differently given this approach of 90% in index funds and 10% in individual stocks. I know I would. My 10% would likely consist of at least a few individual stocks and not just one. 2nd, I would look at the two buckets of money as separate and would not transfer money between the two. Thus, the most you could lose is 10% of your money and that would be if all the stocks you picked went to zero (a rather unlikely scenario).

    1. yeah those were my thoughts too, if you’re going to day trade don’t think of it as a separate portfolio and don’t re balance from the index funds to even out the losses from the day trading portion.

    2. It’s not unlikely I have seen it happen. This is critical advice to separate the two. You are right that treating them as separate solves some of the problem Dave. I know people who have made the above mistake and it is catastrophic.

    3. I have been fully invested in 12 Canadian and 14 US stocks since 82 and sold one stock in that time ( GE and replaced it with AAPL). I buy quality blue chip dividend stocks with the Intention of keeping them forever, and have done quite well with time in the market, not timing the market.

  5. So much of it is luck. B/c I live in San Francisco, I’ve been buying tech stocks since 2001. I figured, if I can’t ride the tech train since I worked in banking, I might as well buy all the companies that would reject me as an employee.

    Buying Apple, Google, Facebook, Netflix, and Tesla was just luck. I just try and limit at most 20% of my public investment portfolio to individual stocks. And if I get lucky, then I try and turn the funny money into real assets like SF real estate.

    Our wealth is mostly due to luck. Be thankful everyone!

    Sam

  6. Does anyone actually do this though?

    10% of my money goes into ‘gambling’. If I have $1000 to invest, $900 goes into my Questrade ‘smart person investing’ account (ETFs) and $100 goes into my ‘silly gambling’ account. From that point on they’re completely independent. If I decide to be an intelligent person I could sell winning stocks from the gambling account and transfer cash into the index funds, but money will never go the other direction.

    1. This is what I do. Money only goes one direction. I watch my earnings on individual stocks and transfer 50% of profits over to my index funds every 6 months or so. It works for me. I would never re-balance between the two.

  7. OK, I freely admit that I did not read every word of this article and I glossed over the charts but the thesis of your article is very, very true. You will have saved lives with this one and I hope that the recent traders who seem to be flooding the markets at this time are able to read this and benefit from your insights.

    I am not in complete agreement that one can invest in the markets themselves. I think that it should be very clear to anyone considering this that, in your experience, managing your own investments requires research, patience, focus, dedication, and nerves of steel. I have chosen instead to work with an advisor who has the smarts and the experience to effectively manage my portfolio. So far, so good but I freely admit that I went through several different advisors before I found the right one. Unless one chooses your approach, or mine where I have an arm’s length relationship, then one runs the risk of becoming a gambler.

    Another piece of advice that I am filching from The Bearded One ™ is that portfolios are best based on ETFs and not a selection of individual equities unless the portfolio is in the seven figures range.

    I really wish that your expertise (as a seminar perhaps?) and your book were widely distributed in schools across the country. So many people would benefit.

  8. great post ..

    however Garth recommends holding individual stocks in a large Portfolio , but many many stocks

    i presume because of the fees for ETF’s ?

    how about you do you not consider the fees as costly in your large portfolio ??

  9. Crazy, so every single dividend investors are wrong this whole time? You don’t say…

    It’s easy to sell when it hits the threshold, how do figure out the price to buy back then? Your trying to tell people to time the market, when retirees want a hands off retirement.

  10. In all honesty, I don’t think anyone re-balances between their ETF holdings and their individual stock holdings.

    It is a nice theoretical writeup to exemplify why one wouldn’t do it, but I don’t think anyone actually was doing it.

    Like TW mentioned above, those of us who set aside a “gambling” account allocate a finite amount of CASH to this account, not an ongoing PERCENTAGE. This way there is never re-allocation between those two accounts.

    And for Duh: dividend growth investors use yet another different methodology, or way of thinking of their portfolio, than index investors. The example in this post has nothing to do with dividend growth investing, dividends were not even mentioned. If the stock STK was paying dividends, and continued paying through the downturn, than buying more at a price of 25$ might actually be wise. Though that should not be done with money re-allocated from the index ETF but with either new money or the dividend income. If STK stopped or reduced their dividends than most dividend-growth investors would get rid of it pretty early at the first signs of stress to the dividend.

  11. There’s quite a difference between day trading and owning individual stocks as part of ones portfolio. As others mentioned above, any person that would continue to transfer funds to support the falling 10% side should not be managing their own portfolio. This article seems to jump from one to the other. From owning a stock as a long term investment to day trading.
    These examples are scare tactics and represent highly unlikely extremes.
    Who would own one stock? Who would watch it fall to zero? Etc.
    I usually enjoy reading this blog but this one is a low point IMHO.

    1. I had to think about that one. Marmot. I don’t know. They’re just not my first choice. Or second. Or third. I think you can see where I’m going with this.

  12. Oh gosh, I couldn’t imagine using 10% as fun money. The most I’ve ever used is a few hundred dollars to buy an individual stock. I’ve done this multiple times and made a nice little 20% or so profit. But looking back, having to pay capital gains tax and constantly monitoring the price isn’t ideal.

    This break down makes stock picking that little bit scarier haha

  13. Normally I like your articles and get a lot of value out of them. This one was easily the worst one you’ve done IMO. You wrote about a topic that demonstrably you knew little about and did no research on and were clearly biases and vested in getting a particular slant on it. I have no issue with someone coming to the same result if they had done the minimum of research into (talked to good individual stock investors and traders with good results, poor ones, comparing the differences etc) and highlighting what is involved in trying to ‘beat the market‘ (time, experience and education required) and suggesting that it’s not for the majority. Cool. But your figures and assumptions were ridiculous and were pulled out of the air. If anyone buys individual stocks and does what you suggested, they should 100% not be doing it. Many, many do not. This whole article was just wrong.

  14. Yeah, I have to agree with many of the other posters. This example is pretty flawed. Along with my ETFs, I also hold individual stocks in a Dogs of the Dow strategy, which has shown to outperform ETFs over time. I can also write covered calls on these blue chip stocks to generate income. Holding individual stocks is fine if you know what you are doing. Your example is just not realistic.

  15. A situation with a similar dynamic happened to me when I used to invest in individual stocks. Loyalty, or a myopic view of the inherent value of a single stock can be very damaging to the value of a portfolio. ETF’s are a great way to remove the cognitive problems that humans suffer from as investors.

  16. Wanderer, if there were an award for “best comedic writing on a finance blog of a hypothetical CEO of a fake company”, you would win.

  17. Contrary to what some others may think, this is one of the most invaluable article I have read. The one reason why index funds are so sustainable (vs individual stocks) is as explained here.

  18. I enjoy reading your posts but this one made me scream inside as I don’t agree with what you said here to the extent I decided to leave a reply for the first time. I do passive investing (100% US tech stocks in retirement accounts) and active trade with a separate account. Yes active trading is probably not best course of action for most but if you know what you are doing you can grow your wealth and reduce time to FI with risk-defined, income generating active trading.

  19. By the time a person is convinced that active trading is a path to success and wealth, he/she needs to know the opportunity cost of full-time trading. As an ex-trader, I stopped trading many years ago when I realized few critical things, one of which is the opportunity cost. I read of more cases of successful multi billionaires and multi millionaires running productive businesses than the paltry multi millionaires and multi thousand-naires doing full-time trading. Trading is neither productive nor a business no matter how you see it. You are not generating anything useful or valuable to anyone, even to yourself.

    In case someone ask what about the multi billionaire fund managers doing trading, well these people got rich from charging management fees in trading other people’s money.

    1. Opportunity cost of full time trading? If you have a billion dollar idea you are itching to execute go for it. If you are one of the many doing a 9-5 pm grind there is no harm learning how to trade so you can diversify your income streams. I started active trading, started making consistent income where I turned my profits to long term positions.

      1. There are far more cases of people going from broke to wealthy as multi millionaires and multi billionaires running businesses than cases of people becoming the same thru stock / option / futures / forex trading. Sure you have the right to repeat others’ mistakes but many years from now you will say things differently from today. The lessons you will learn will inevitably be expensive.

        Do not be fooled into thinking you are right on it just because your trading outperformed everything else for some time. The multi billionaire traders that I learned of became billionaires either by trading other people’s money or cheating their own customers.

        If you are an economic slave, then your chance of getting rich by being productive and running a business is far much higher than from trading.

        It’s like answering, “Do you want a 50% chance of success or 5% chance of success?” Reasonably you would go for the 50%, not the 5%.

        Even if you do found the holy grail of trading, then so what? What is your equity curve and your yearly ROI? I learned of small businesses that earned more than 100% ROI per year that they open up second shop in the second year and subsequently. That’s the opportunity cost for you, making 20% to 25% at best instead of 100% and beyond.

        1. Do you know how many businesses fail every year? Many. Let me be more clear. Many many. Like over 90% +. Running a business and trading stocks have similar risks. The most important that of inexperienced and naive people not doing their research thinking that “their way” will work. And then it doesn’t.

          We each find our own way, whether it be trading, running a business, gradually saving and investing a portion of your paycheque into index ETFs, or, better yet, drinking away the rest of your life in a ditch on the side of a road.

          Don’t take it from me. I’m just a self made millionaire who invested a portion of his paycheque a bit at a time. 🤑🤑🤑

          1. Yes, there are many many cases of business failure, but the point is how many times do you hear of people becoming multi millionaires from trading vs those from running a business? Similarly, how many times do you hear of people becoming multi billionaires from trading vs those from running a business? I am talking about the count and the probability.

            You say you are a self made millionaire. Let me ask you how did you become a millionaire in the first place? Assuming you started broke, were you actively trading until you became rich from trading?

            Overall, trading does more harm than good. I was a trader, developed my own algo trading system (for market structure demand/supply analysis), and pursued the CFA program. In the past, I was very pro in trading until I learned there are limitations to trading, i.e. you can only get this rich (small time millionaire instead of billionaire) because of market liquidity. And you will always go to zero over time because you are playing against a group of people that can swing the market without the need for capital and inventory. Most people trading have no awareness of such group of people whereby they can affect swings with no capital and no inventory.

            Now you are making some paltry money because you vulture off the small traders. If you ever have big dreams like I did, and assuming you have the right competency and resource, you may quickly learn the top predator of the pyramid that you will face if you want to reach the top is the kind of predator that can win without the need for money and inventory. When you finally realize this, you realize trading is pointless if the top cannot be reached.

            The people that become rich from trading are those that prey on small traders. Their wealth is limited. The filthy rich have bigger goals elsewhere.

            1. I see you’re adding a factor of morality into your argument. That’s a mistake. There is no prey or predator. There is only opportunity and whether you think that opportunity is worth your time. It’s not my job to police who is a naive fool and who isn’t or feel bad that they let themselves be fleeced. Opportunity is opportunity. That’s it. The best way to learn is by getting burned. Either you learn and adapt and become better or continue to be exploited.

              Yes, I became a millionaire trading. It’s tiring though which is why I now do ETFs through a passive portfolio. Also, there are other things I want to spend my time on and that’s where my focus is now. Not sure I understand why you feel the need to use algos or other “systems” though. It’s not that complicated.

              And yes, I’ve owned and built up companies too. Some successful, some failures.

              Overall, I only talk from experience. The “fake it till you make it” types are easy to identify and avoid (their facade falls off eventually because they can’t keep up something that isn’t them beyond a certain timeframe).

              Here’s the real kicker for me. Why do you think being a billionaire is the epitome of success? Are you suffering from envy? What happens when trillionaires come into existence? Will you then chase that too as the epitome of success? Seems pointless.

              1. I see you still fail to understand my points correctly. Nothing to do with morality. Everything to do with the probability and magnitude of potential success.

                An algo is not necessarily complicated. An algo is needed if there is a need for an automated system that duplicates what a trader does so he may have his time elsewhere instead of always in front of the computer. The complicated part is only in the programming, and not necessarily in the concept.

                Being a billionaire is just a casual yardstick used for this discussion. Billionaire or not, that’s not the main point. The main point is whether you do something that has much higher chance of success and wealth vs something else that has much lower chance of success and wealth. Logically, a person should choose the one that gives the highest chance.

                It is far easier for a person to be a billionaire from running a business than for him to be a multi millionaire from trading. Trillionaires already exists, maybe you just don’t know it. Nothing to do with envy. Your lack of understanding is the pointless one. If your business fails, it’s probably you don’t really have much business sense.

                Many people like to start a business selling vanity products that people either do not use, or use once a year. In this case, failure is assured.

                1. I haven’t failed to understand your points correctly. They’re actually irrelevant. That’s the point I’m making. What I see when I read your points are that they are all from a point of theory, not practicality. “Being a billionaire is a casual yardstick.” Are you for real? There too, I already know the answer. No. “If your business fails, it’s probably you don’t really have much business sense”. Seriously? You think most successful business owners made it on the first shot? Based on your last comment, I can see you’re actually a nobody trying to be a somebody. Remember what I said before. Fake it till you make it. You’re pretty obvious.

                  1. Your points are equally irrelevant to me. Your whole argument is useless and pointless to me. Theory? Not practical? Wow! I was a trader, developed my own trading system, and pursued the CFA. These are all theory to you? Are you a retard or something?

                    You still do not understand my point correctly, no matter how much you pretend to. It is easier for a camel to go thru the eye of a needle than a …. You do not question why Jesus was obsessed with camel or the needle. They are just metaphor to explain his main point. Likewise, when I say it is easier to be a billionaire running a business than to be a millionaire trading, they are metaphor to explain why success thru trading is much harder than everything else. Are you retarded in understanding?

                    In business, one can make mistakes and learn the right formula for higher chance of success. In trading, the same formula that work today may likely fail tomorrow. Running a business is more science-based. Trading is speculative, as in what works today may fail tomorrow. Arthur Hayes of Bitmex rightly refer to traders as degenerate gamblers. Clearly, you have no business sense.

                    I am a nobody, but I am not trying to be somebody. I am just advising people not to trade. Is that an act of trying to be somebody to you? Are you retard or something?

                    I appear fake to you. That’s probably because you are fake yourself. When you are a fake, you tend to see others equally just as fake. And that’s your problem, not mine.

            2. points well noted but bear in my mind you’re on a website devoted to frugal living. “small time millionaire” is precisely the goal and mega wealthy billionaire status is not the point for 99% of the readers here

              1. My point is not about trying to be a billionaire. My point is if you want to be small time millionaire, there is a better option for you to take to accomplish such goal with much higher chance of success vs trading.

                Some people may say running a business is equally risky and I beg to differ. In running a business, you stand a 90% chance to fail but this is over a 5-year period statistically. However in trading such 90% chance of failure is within the first year itself.

                1. So, what business do you run? When did you make your first million? Billion? Trillion? Gazillion? Why do you feel the need to constantly name drop to try to beef up your position and instead have an original thought? Why did you give up after you got your CFA? Are you easily influenced by people with acronyms shown after their name (CFA, MBA, LLB, WTF, LMAO, PHD)? If running a business is based on science, why do we have so much business failure? If running a business is based on science, why is the business cycle so unpredictable? Why don’t you run your own blog and gather your own readership who believes what you’re saying? Is everyone a retard who doesn’t agree with what you’re trying to push? 🤯🤯🤯🤯🤯

                  1. I am pretty convinced by now that you are somewhat a retard.

                    First, wealth is not something to brag about. Wealth comes and goes. Nothing is permanent. Today a person may be rich. Tomorrow he may lose everything. How rich I am is not your concern. Unlike you, I have no interest to disclose whether I am a millionaire, or a billionaire, or a trillionaire.

                    Second, you have no idea how much you lack in understanding things correctly. Your comment that I name drop and not have original thought is nothing but nonsense.

                    Third, I gave up trading because after I developed my algo to analyze over 17 years of futures data PLUS my experience in trading and understanding of the market microstructure, I realized there are significant limitations to it. By the way, I bet you have no idea what market microstructure is. There is a lot that you do NOT know, but somehow you are foolish enough to think you know about the market. There is a big difference between you (a manual trader) and me (a manual trader + proprietary indicator inventor + algo developer). It takes a person to be well versed in the market before he can even develop an algo to trade systematically and unemotionally. You on the other hand, a manual trader, obviously have no idea what I am talking about.

                    Fourth, I mentioned CFA along with trading experience and algo development just so you know what I know is not wholly theory. I know what you know not.

                    Fifth, business failures are generally because of retards like you that take fancy in starting a business just for the heck of having a business, selling vanity stuffs that nobody want. Why do you think they emphasize “hair on fire” kind of product/solution? Business cycle unpredictable because of central banks easing and restricting credit, creating booms and busts in the economy. Basic economic 101. If you are a trader, then by right you should already know this.

                    Sixth, you talk of starting my own blog and calling people retard for not agreeing with me. I want to point out that you are a hypocrite. Your first comment called out some people as fools for having a 75% stop loss. You are so stupid you cannot even understand that 75% figure is just an example to explain a main point, i.e. having a stop loss, never mind if it’s 75%, or 50% or 25%, or 2%. You do not appreciate the generosity of the wanderer in giving such good tip on not rebalancing individual stocks. You think you are smart and the wanderer is a fool. Even a CFA-educated guy like me would agree with the wanderer. Who are you to disagree and then call people fools? Now you say I call people retard for not agreeing. You are a hypocrite.

                    1. You’re right. I don’t know everything. I don’t need to. I do know enough though. Enough to provide for a comfortable life. Enough to know who fools are. Enough to ask questions and point out when things don’t make sense (yeah, a stop loss with a 75% loss is silly and shouldn’t even be used as an example except to say this is not how you use a stop loss).

                      Whether I brag about my wealth is not for you to decide whether it’s appropriate. Might it be in poor taste? Obnoxious? Maybe. On the other hand, who cares? I like to do it and that’s all that matters. Do you also sneer at those who drive a fancy car or live in a fancy pants house? You do realize this whole website is about bragging about their wealth and success. Thumbs up to them for it. Hopefully, others learn from it. It’s good to feel proud about it and not have little haters shit on them because they don’t keep their head down.

                      Lastly, you’re not CFA “educated”. You might be CFA schooled. Education is about experience and applying that learning. Not about schooling. Stop trying to fit things into a small black and white box. Life doesn’t work that way.

                  2. You know enough to ask questions. But you do not know enough to judge and condemn. Otherwise, any Tom, Dick, and Harry can judge and condemn based on the little knowledge they have. Check out the Dunning-Kruger effect. You are at the leftmost of the curve.

                    This whole website is not about bragging. It is about providing invaluable investing knowledge for free. If it is about bragging, then you wouldn’t be visiting it regularly.

                    Do you get a lot of haters? Is that why you assume I am a hater too? Is that why you think the only right way to go is to agree with everything you say even when you are wrong? Is that your logic? Is your moral standard based purely on money? Yet you question me for using billionaires as some yardstick/benchmark. What a hypocrite.

                    Look at your nonsense. You are full of it. What’s the big deal between “educated” and “schooled” so much so that you find it worthwhile to make a point out of it? You think you are the only one with experience? You think everyone that receive schooling have no experience? You think people that receive schooling cannot learn any further in any other way? How much do you even know about life that you readily brag about wealth that is generally fleeting? You accuse me of pretending to be somebody. Yet you are a nobody yourself but pretend to be somebody. Shame on you.

                    In life, I met a lot of people like you that receive little formal education and act like some smart alec going around making things up that are generally untrue.

                  3. There is so much you do not know and yet you think you know enough based on the very little experience you have. Truly pathetic. It is no wonder why you fail in business.

                    Based on the very little experience you have, you assume I am all theory and no practical, as if a person that is strong in practical cannot have different opinion than yours.

                    Do you have jealousy over people that are academically qualified? There are a lot of rich people I know that express regret for not pursuing proper schooling in their younger days, that they will not repeat the same mistake with their children. Yet, here you are talking about experience over schooling. Fake it till you make it, as you say. You are indeed a faker.

  20. This is the sort of thing I wish I read back right before the 08-09 Great Recession. I wrote a whole post about my worst financial mistake and individual stocks vs index funds…

    I think you’ll certainly get some pushback, but your root point is valid: on average, index funds win out for ordinary people.

    Certainly, many many people will manage to beat the S&P on some years — and even over fairly long periods. But, many more will not.

    I think that’s the core point – too many of us think we’re above average. By definition, on average, we’re not.

  21. There is a difference between Trading and investing

    And because person A can’t trade (doesnt know how or is emotionally inequipped ) doesn’t mean there aren’t thousands of successful traders. Do some due diligence,

    1. Successful by what measurement? 25% ROI per year, every year? 50% ROI per year, every year? 100% ROI per year, every year? Or slightly enough to beat the return from fixed deposits in addition to having some pride?

      Veteran traders always ask for the equity curve for validation, and from there the CAGR is measured over a period of time. There are people that can’t trade. But there are also people that can trade and realized trading is not the ultimate.

      To reach the top, there is absolutely nothing to do with trading. Jim Simmons of Rennaisance Tech outperform in his trading by front running his own clients. He has two funds. One reserved for his own people that outperform wildly. Another fund only for others that continue to underperform badly. Steve Cohen the billionaire made his money doing insider trading. Many other traders managing billionaires got rich and successful by trading other people’s money, not their own. Wise up. There is little that most traders know. The learning curve is steep. The more you know, the less you will be incentivized to trade. Trading appeals only to the poor and stupid.

  22. Great Article Wanderer and FIRE Cracker. This is such important advice. I have seen so many families loose a lot of money because of stock picking and this is critical. Thank you for talking us through it and helping us.

  23. Great article! I used to do a little individual stock trading, but wasn’t able to consistently turn a profit, so I stopped. A balance ETF portfolio with regular rebalancing might be “boring” but it actually works all the time for everyone (unlike gambling on individual stocks).

    Thanks for sharing!

  24. Not one of your better articles, IMHO. The hypothetical case you set out is spot on of course, you should not re-balance from your ETF portfolio to your individual stock portfolio. But what might have even made your point stronger is if, alongside this, you had another hypothetical case whereby the individual stock portfolio was a set cash amount and there was no flow of money between it and the ETF portfolio and a ‘control’ case which was 100% of the money invested into only an ETF portfolio.

    Presented the way you have done just shows your bias instead of driving the point home.

      1. You know, you are kind of self-conflicting person. You sound offended that I kept bringing up billionaires and yet you confess you feel happy to brag about your wealth. Are you trying to say you feel upset that others are rich, but at the same time you feel happy you are rich? You know what that call? Envy.

        I don’t sneer at those that drive fancy cars, but what about you? Do you sneer at me for taking the billionaires as examples? Judge yourself before you judge others. Your shirt is no cleaner than others. In fact, much dirtier than others.

        You are really stupid. Judging by your comment, I guess you lack formal education. Let me tell you this, knowledge/experience/wisdom whatever you want to call it, is gained from BOTH book-smart and street-smart. I met a lot of people like you that receive little formal education and act like some smart alec going around making things up that are generally untrue.

        The best education/school or whatever you want to call it is a balance between book-smart and street-smart, combining both theory and practice. You think your practice is everything? Let me tell you this, you ain’t seen enough yet in your life. Not even significant enough to impress me.

        You talked about black and white box and yet you just expressed your discrimination on formal schooling over experience, while I emphasize a balance of both. You are a hypocrite. No wonder you fail in business. I bet your successes were mainly pure dumb luck.

        You talk about experience yet you do not realize wealth is fleeting in life. Obviously you don’t have enough experience.

  25. In this example, you can only “buy the dip” if your allocation pie expands especially because the 10% stock allocation is a side play not something you would re-allocate along with your 90% mutual funds.

    Expansion of the allocation pie for most small investors is probably via monthly dollar cost averaging. If they contribute $500/month, then it’s $450 to mutual funds and $50 to stock through auto-investment.

    For myself, in addition to my retirement options, I have a tax-efficient low-cost account where I invest additional funds each month. I have high risk tolerance, so it’s mostly very aggressive mutual funds/ETFs along with some high yield fixed income investments. Beyond that, I make some short term individual stock transactions with intent to make 10-20% sometimes more off of companies or sectors that I know well. At this point, I don’t use leverage, and I don’t buy/sell options. I usually only take 1-2 short term positions at a time, so I can focus intently on those positions. Not every trade works out, but because I am committed to my overall strategy, I am able to profit more often than not.

  26. Title of article is misleading. Should be “How Trading Individual Stocks Can Destroy Your Portfolio”. The dividends from individual stocks make up about 15% of my retirement income and I am happy to own them. Owning stocks is not the issue as ALL large equity ETF holds some stocks. CPPIB itself holds over 3500 different company stocks from around the world. Bryce and Kristy obtained FI through their strategy and their are lots of practical lessons to learn. There are lots of ways to obtain FI. For me holding individual stocks is just a small part of a larger plan.

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