The question of the ideal starter strategy arises, particularly for young investors who want to invest in the stock market for the first time. Purchasing individual stocks specifically is not the right approach, explains an expert.
• Newcomers to the stock market like to bet on well-known stock names
• Morningstar expert advises against stock picking
• Diversification less risky
The performance of successful stock market giants such as Apple, Tesla, NVIDIA & Co. also arouses desire among newcomers to the stock market. But how successful is targeted stock selection for stock market starters? An expert has a clear opinion on this matter.
No stock picking for beginners
Christine Benz, head of personal finance and retirement planning at Morningstar, does not believe it is promising for newcomers to the stock market to specifically select supposedly promising and well-known stocks that have performed well in the past and from which they expect further upside potential.
The expert tells CNBC’s “Make It” that she thinks choosing individual stocks is a “terrible” investment “for people who are just starting out.” Benz particularly points out the high risk associated with this, as there is always the possibility of a price collapse for individual stocks, which significantly reduces the return on the portfolio. Basically, the broad stock market has historically shown an upward trend, but anyone who limits their investments to a few well-known names runs the risk that one or more of these decisions will flop – a very likely scenario for those new to the stock market, according to Benz.
Lack of experience in stock valuation
In their opinion, the reason for this is particularly the fact that stock picking requires a much deeper evaluation than just making a selection based on the popularity of a company. “People make decisions about which individual stocks to invest in based on companies they know,” she said. “They often don’t know how to do due diligence or research companies, so they often choose stocks without having the information they need to make good decisions.”
Diversification in view
Instead, newcomers to the stock market in particular should concentrate on building a diversified portfolio – with low-cost investment funds and ETFs, advises Benz. “If there is a single type of investment for which there is a lot of data that produces a good result, it is the use of market-broad index funds.” So, if you’re new to the market, it’s better to spread your bets across a large portion of the market, thereby reducing the likelihood that your returns will be reduced by the decline of a single investment.
In her opinion, there is nothing wrong with bringing individual, well-known individual stocks into the portfolio – also in view of the fact that this way you can get young people excited about the stock market, since owning a single share is “undeniably more exciting” than owning one ETF. Nevertheless, you should make a clear distribution of shares in the overall portfolio. Benz sees trying around ten percent in individual companies “at the edge of the margin” as a “sensible way of thinking”. However, 90 percent of the portfolio should be broadly diversified.
Charly Munger had a different opinion
Diversification as the ideal of a well-balanced portfolio is considered important by many experts, but star investor Warren Buffett’s business partner, Charly Munger, who died at the end of 2023, had little to gain from this way of thinking.
“An idiot could diversify a portfolio! Or a computer, for that matter.” However, a broad portfolio diversification is not suitable for investors who want to achieve top performance. “It’s setting yourself an impossible task. What fun is it to solve an impossible task over and over again? I find it torture. Who would want to do that?” said Munger at his Daily Journal Corporation’s 2019 annual meeting .
At Berkshire Hathaway’s 2023 annual meeting, Munger reiterated his distaste for diversification: “One of the nonsensical things taught in modern college education is that broad diversification is absolutely necessary when investing in common stocks… That “It’s a crazy idea.” In his opinion, investors should instead concentrate on a few stocks that have been identified as the “best ideas”, while a broad diversification in the portfolio is more of a worsening.
Still, Munger acknowledged that diversification “makes sense to a certain extent,” such as “if you don’t know what you’re doing.” This is probably exactly the case for many newcomers to the stock market.
Editorial team finanzen.net
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