There's nothing wrong with investing solely in exchange-traded funds (ETFs) if that's your comfort zone. An ETF gives you a basket of stocks that tracks the performance of an index, like the S&P 500, which represents more than 80% of the U.S. stock market by market capitalization.
Considering that stock market returns average 9% to 10% annually, simply achieving market returns over a long-enough period is a surefire way to build wealth. But what if you think you can beat the market? Here are four signs you're ready to graduate from investing in ETFs to picking individual stocks.
1. You already own solid ETFs
Before you start investing in individual stocks, it's essential to have a diversified portfolio. The risk of losing money when you invest in a single company or two is high. But over a long-enough time stretch, the U.S. stock market has always delivered positive returns.
ETFs are one of the best vehicles for getting the diversification you need automatically. Plus they're traded efficiently via stock market exchanges, and the fees tend to be low because the vast majority are passively managed.
2. You know your investing style
If your No. 1 investing goal to make money, guess what? That's the same goal every single investor on the entire planet has. Without having clear goals, you're less likely to succeed at picking your own stocks. A good place to start is to figure out your investing style.
A value investor looks for stocks that the market has undervalued. Essentially, they're bargain hunters who believe they'll earn strong returns once other investors recognize a company's true underlying value.
Growth investors, on the other hand, aren't looking for cheap. They're willing to pay a premium for stocks when they believe a company can deliver faster-than-average growth of profits or revenue compared to its industry peers or the overall market.
Still not sure which type of investor you are? Learn the basics of how to value a stock to get a better sense of your investing style before you graduate to individual stocks.
3. You have at least a moderate risk tolerance
If stock market volatility causes you significant stress, you may be better off sticking to ETFs. Investing in any one stock is significantly riskier than an ETF. For that reason, you should only start investing in individual stocks if you have at least a moderate risk tolerance, which means you can handle losing money in the short term.
4. Your investment thesis is strong
For every stock you invest in, you should have an investment thesis. Essentially, you should be able to make the case for why you believe a company is worth investing in. Maybe it has a huge competitive advantage or a fiercely loyal customer base. Or perhaps you see it as a leader in an industry poised for serious growth.
If you're willing to commit to investing only when you have a good thesis, it's a sign that you're ready to make the leap from an ETF-only portfolio to individual stocks. Write down your investment thesis for every individual stock you buy. Doing so can help you avoid jumping on a bandwagon and overpaying for the stocks that everyone else is buying today.
Revisit your investment thesis for each stock you buy from time to time. Sometimes, you'll find that you got it totally wrong. But if you can learn from your mistakes, you'll be a far more successful investor.