Threading Needles

I was asked a question the other day. It’s a question I commonly receive from folks who know I’m in the “investment business.” The question went something like this: “Are there any stocks that look really interesting to you right now?”

As it probably does each time I’m asked this question, my response undoubtedly underwhelmed the questioner. It certainly left them wanting.

I commented that I don’t recommend individual company stocks.

“Isn’t that your job?” was the response.

I understand the sentiment. And it’s true that I enjoy reading about stocks and following analyst commentaries on the attractiveness of certain companies. Truth be told, there was a time I considered the prospect of joining or starting an investment company. Not so much anymore.

What changed? My experience level.

 I learned firsthand – and through the experiences of others – that successfully investing in individual companies is hard. In fact, that’s probably putting it too mildly. Successfully investing in individual companies is nearly impossible.

To understand why, we must first define “successfully.” For me, that means beating the returns of the S&P 500, which is a collection of the 500 largest publicly traded companies in the U.S. This is the benchmark. Why? Because buying an investment fund that tracks the S&P 500 is cheap and easy to do. Plus, the benchmark has a long history and is tremendously difficult to outperform over time, as well documented by thousands of financial researchers and writers.

In short, the S&P 500 bundles hundreds of wonderful companies into one, neat investment package. It should be the base of all investment portfolios.

With that explanation out of the way, let’s talk about why investing in individual companies is so difficult.

To do well as an investor, you must identify attractive investments and then be willing to allocate big money once you find the right situation. Investing in the wrong situation obviously doesn’t work out. But investing a small amount in the right situation doesn’t do you much good, either. You need the right situation and big bucks. That’s the secret combination.

But finding and investing in the right situations, over and over, is tricky. It’s like threading a successive line of needles.

Pretend each investment you purchase adds a new needle to a line of needles. You can only push and manipulate the string directly before the eye of the first needle. With one investment – one needle – that’s not too complex. But with each new needle you add, the more intricate the process becomes.

Warren Buffett once told a group of college students that too many people simply want to dabble in investments. People hear of a company and quickly buy it online with no transaction fee costs. But they don’t know a thing – or maybe just a little – about the company. They don’t know the management team. They don’t know why customers buy the product or service. They don’t know how much expense it requires to offer the product or service. And they don’t know the company’s competitors or what new technologies could disrupt it.

Buffett told the college students they would be better off if they limited how many investments they could make over a lifetime. “If you had a punch card with only 20 [investment] punches – you weren’t going to get another one the rest of your life – you would think a long time before every investment decision,” Buffett explained. “You would make good ones, and you would make big ones.”

That doesn’t happen for most people. In reality, people get excited about a company after little-to-no research, invest a relatively small amount of money into the stock relative to their net worth, and hope it leads to fortune. In that case, the strategy is simply to get lucky.

Frankly, that’s just not a strategy I can recommend.