One couple of very conservative investors had the unwelcome shock of a $19,000 bill from the IRS. Where did all of this supposed income come from? Believe it or not it was from inherited stocks. They were all in mutual funds that the couple didn’t control, and the managers decided when capital gains were “realized” through a sale and reinvested in something else. The couple had to sell the new investments just to pay the tax bill.
There comes a point in your investing career when you begin to wonder if those who run the mutual funds are worth their expense. Funds often hold dozens of stocks to make you feel that your money is well diversified. In truth, as few as 20 stocks will make a good portfolio if they are in different industries. If you buy stocks that average $20 a share (never go lower than $10), and you buy in 100 share lots, your entire portfolio could be nearly as risk free as most mutual funds at the low price of $40,000.
When you manage your own portfolio, it’s up to you when the stocks are bought and sold, which can have huge tax implications. If you get rid of a loser, you can sell something that has appreciated and avoid paying tax on the gain. Managers are only interested in their rate statistics, not your taxes.
If you’re already well diversified through a mutual fund, adding individual stocks won’t increase your overall risk, so you can invest slowly over time and start gaining control immediately. If your mutual funds outside of your 1040K (which is out of reach) hold $20,000 and you still have long-term money to invest, it might be time to go out on your own.
Remember to focus on the long-term. These are investments that you must plan to hold for more than 5 years to reap their benefits. Unless something truly tragic occurs, such as a patent argument or a suit from the FDA, you must be willing to ride out the ups and downs. Little is gained by timing.
If you take unnecessary losses, it will be difficult to recover. Say half of your stocks lost 10% for you this quarter. The market made 2%. You’re losing money! Quickly you sell the losers. So out of an investment of $10,000, you recovered $9,000. Thank heavens!
But here’s the rub. To catch up, you’re going to have to earn 11% That’s more than the the yearly average of the diversified stock market. Individual stocks rise and fall everyday. You would need a whole year of luck just to get even. Can you pick stocks that you know will do that well? If you stuck with the other stocks, you might find that the drop was due to an erroneous news report, a block sale from a large investor, or a lawsuit that was settled out of court. Even if you don’t know, it’s quite possible that the $10,000 you invested was the proper price of the company. Rebounding stocks happen all of the time. So don’t look at your stock very often, and don’t sell them unless the company is in continuous trouble or you need the money desperately.
Where do you start? It’s a depressing fact that the Wall Street’s Journal’s dartboard beats its rival financial advisers on a regular basis. Read the financial statements, choose from different industries, look at where the future is going. Ask a professional if you want to, particularly an accountant who understands what the financial statements mean in frightening detail. Then leave your stocks alone to grow for you.