Picking stocks is a 'terrible idea' for young investors, says expert—what to do instead
If you make New Year's resolutions, 2024 may be the year you or a young person in your life begin investing.
But where to start?
Your first instinct may be to buy shares in a few well-known companies — firms whose stock prices you're confident are bound to rise. After all, the internet is replete with stories of just how well you could have done if you got in on the right stock at the right time.
But you'd likely be making a mistake, says Christine Benz, director of personal finance and retirement planning at Morningstar. A user on X, the site formerly known an Twitter, recently resurfaced a post of hers from 2020 which reads, in part: "Individual stocks are TERRIBLE investments for people just starting out."
"I stand by this point," she responded.
Rather than starting their investing journey with a handful of individual stocks, young people should focus on building a diversified portfolio using low-cost mutual funds and exchange-traded funds, Benz says. Here's why.
The risks are too great with individual stocks
Financial pros like Benz urge investors to build broadly diversified portfolios for a reason: While the overall historical trajectory of the stock market has trended upward, any individual stock has a chance to decline sharply in price and destroy your portfolio's returns.
Buy sinking your investments into a few well-known names, you're putting yourself in major danger if one or more of your picks flops — a likely scenario for investing novices, says Benz.
"People are making decisions about what individual stocks to invest in based on companies they're familiar with," says Benz. "They often don't know how to do due diligence or research companies. So they're often going to pick stocks without the information they need to make good decisions."
Benz's original statement from June 2020 rings even truer in hindsight. In the bull market that sprung from the Covid-19-related downturn, exuberant investors were bidding up just about anything that felt like a stock of the future.
Look at where some of those companies are now. Peloton, which traded for about $50 a share when Benz tweeted in 2020, trades under $7 as of market close on Jan. 8. Zoom was on its way up and trading at about $243 a share. You could buy it for $68 as of market close on Jan. 8.
If you're just starting, you're better off spreading your bets over a large swath of the market, decreasing the chances that a decline in a single investment will derail your returns, says Benz.
"If there's a single investment type where there is a lot of data to support that, where you'll have a good outcome, it's using broad market index funds," she says.
An index mutual fund or ETF aims to replicate the performance of an underlying market benchmark. Purchasing an ETF that tracks the S&P 500, for instance, gives you exposure to some 500 stocks. And because these funds aren't overseen by high-priced managers, they come with low or, in some cases, no annual fees.
You can still use stocks as a learning tool
Are experiencing sharp declines in your portfolio necessarily a bad thing? Many people think they're a valuable lesson, says Benz.
"There are people who adamantly believe that it's the best way to start investing because you experience viscerally what investing is," she says. "Plus, you have a connection with that company, so you have a sense of being a business stakeholder."
Benz argues, though, that you don't have to put yourself or a young person in line for a major loss to learn lessons about prominent companies.
"Look at the list of the top companies in an S&P 500 index fund, talk about what they are, and you'll see a lot of high fliers in there that a young person might be excited about," she says.
The top-five stocks in such a fund right now: Microsoft, Apple, Alphabet, Amazon.com and Nvidia.
Still, owning a single stock is undeniably more exciting than owning an index — especially if you're dealing with a youngster you're trying to get excited about stocks. For those looking to impart a lesson, "if you want to make a token investment in a company that your kid likes or understands, I don't think that's a big deal."
And if you're investing for yourself, the same rough principles apply. You'd be wise to devote around 90% of your investments to a broadly diversified portfolio, says Benz.
"Then, if you want to dabble in individual companies around the margins with that other 10%, that seems a sort of useful way to think about that."
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