Don’t Buy Individual Stocks

Robinhood is a discount brokerage service that has become increasingly popular.  They were founded in 2013 and quickly have revolutionized the financial services industry. They have millions of customers who are first time investors with many being within the millennial age group.

Robinhood gained notoriety by offering commission free stock trades and a crypto currency (bitcoin) trading platform.  It is often quoted that they have democratized investing for small investors.  This forced other large brokerage services such as Charles Schwab and Fidelity to follow suit in offering commission free stock trading as well.  On the surface this may seem like a positive, but I have a different view.

It is a good thing that millions of younger people have started investing, but I think trading stocks and crypto currency is the wrong approach.  This has the potential to do more harm than good; this approach has increased likelihood of causing losses causing the new investor to believe investing overall is too risky.

Warren Buffett stated that the best investing book he has ever read is The Intelligent Investor byBenjamin Graham.  Mr. Graham was his teacher at Columbia Business School and was also the co-authorof a book titled Security Analysis with David Dodd which has been used as a textbook in finance classesThe title of the second book should cause one to pause before purchasing individual stocks.  Security analysis is the research necessary to place a value on a business.  Think about that for a moment- are most retail investors trained in finance and accounting?  The depth of knowledge necessary to place a value on a large company in the United States is beyond most people’s abilities.  One would have to understand so many different aspects of a business including but not limited to corporate accounting, understanding SEC (Security and Exchange Commission) documents, real estate valuation, product sourcing, management capabilities, competition, industry trends, etc.  All of this information and more is necessary because when purchasing a stock, you are in affect buying a business that you think will produce more income and grow.  This leads to another problem for the average investor- not only do you have to understand security analysis, but you have to constantly be aware of industry changes within your individual stock holdings. This alone is a full-time job for money managers. What may surprise many is even professional money managers who are trained in finance and purchase securities (stocks) for a living fail the majority of the time to outperform a simple stock market index.  Studies showing this are within the website under the investing section.

Mr. Buffett is often quoted that he does not know what the market will do today, tomorrow, next week, next month or next year. After he does proper valuation estimation and decides to purchase a stock, it is not for the intention of trading.  He does not trade.  He approaches it as owning a good business for the long-term and not as a trading vehicle.  Mr. Buffett takes into account the dividends he will be paid each year along with any retained earnings that help grow the business. Over time, this typically increases the value of the business and many times the stock price.  The short-term market volatility and price swings mean nothing if he believes the business is profitable for the long-term.  Mr. Buffett has stated on many occasions that most investors should stick to purchasing a broad based low cost stock market index and that he knows of very few people within his lifetime that have had the skills to outperform the stock market index.

Crypto currency speculation is another area where there have been wide swings in price.  This is an example of an investment where one is purely guessing whether the price will go up or down.  There are no dividends or retained earnings.  It is similar to betting black or red in roulette.  This is not an investment; it is just a bet.  This is a service being offered that is incredibly risky to the small retail investor.

The original Robin Hood may have taken from the rich to give to the poor but the modern day Robinhood is misguided if they think they are helping the small investor with these services. 

The fundamentals of good investing do not really change.  They involve disciplined saving, investing for the long-term, investing in low-cost broad based index funds and getting on with your life.  One of the most important things an investor can understand is their own limited capabilities.  So, instead of following the latest trends, take the time to self-educate on investing through sources like The Intelligent Investor (first published in 1949) and many other books written by authors who have no profit motive of what you do with your investments.  Some of my favorites are listed within the recommended resources section of my website. 

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