Jake VanKersen: In the past year, investing apps have become widely available. Chances are if you're a regular podcast listener, you know the name of many of these apps, have downloaded them, and used the promo code. The appeal is understandable. You as an investor can buy and sell stocks from the convenience of your own phone without having to use a traditional broker. Still, just because you can buy and sell stocks from your own phone, should you, and if you do, what do you need to know?
Christine Benz: Well, there are a couple of things that argue against short-term trading. One is that at Morningstar we have a window into what has led to success and failure for professional money managers. So, we have a lot of data on mutual funds. And one commonality among the great fund managers is that most of them are long-term-oriented and patient investors, and it stands to reason that as individual investors we should adopt that same mindset with respect to our portfolios.
Another risk of short-term investing, I think, is that a gambler's mentality can set in. If you have luck with one position, you might be inclined to bet bigger or take more risky bets in the future and those could backfire.
And finally, there are taxes to consider. So, as a short-term trader, if you have held securities for less than a year and you have gains in them, you'll owe taxes on those gains at your ordinary income tax rate. On the other hand, if you're a longer-term investor and you've held securities for a year or longer, you're eligible for what's called the "long-term capital gains rate," which is as low as 0%.
VanKersen: Rather than trying to time the market or get stuck in that gambler's mentality that you talked about, Christine, what is a good way for individuals to evaluate individual stocks?
Benz: You really want to focus on two key things. One is the quality of the business, and that means: What sustainable competitive advantages does it have relative to other companies that play in that same industry? At Morningstar, we call that a "moat."
And the other thing you want to focus on is: What price the business is selling at? What's the stock price relative to the company's future prospects? And those things go hand in hand, and they both have to be directionally right for it to be a good investment. Even if it's a great company, if it's selling expensively, it may not be a great investment.
VanKersen: One of the benefits of investing apps is I can put together a portfolio of these individual stocks based on the criteria that you just said. However, that sounds like it's going to get pretty expensive and it would take a lot of time.
Benz: It might take a lot of time and money to build a portfolio that's adequately diversified because, if you're putting together a portfolio, you want to think about having holdings that offset one another. So, when one holding is going up, maybe you have other holdings in your portfolio that are going down.
As a smaller investor, it can be really difficult to build that kind of diversification, which is one reason why I would say that for starting investors, a mutual fund or an exchange-traded fund can make a lot of sense because you can get a lot of diversification without a lot of money and you won't need to spend a lot of time managing the whole portfolio on an ongoing basis.
VanKersen: It sounds like getting into a mutual fund would be a great way to just sort of set it and forget it and find a manager that I really like and all that. But I want to be a bit of a contrarian. You have great advice, but I really want to own single stocks. Can you think of any reason why I would do that?
Benz: I wouldn't rule out investing in individual stocks, assuming that you've done your homework and you've identified good companies and they're selling at reasonable prices. That could be a decent way to go about building a portfolio. One thing I would say, though, is that if you're holding individual stocks, just pay attention to what else you have in your portfolio because you want to make sure that they're not redundant with any other holdings, for example, mutual funds or exchange-traded funds.
VanKersen: Thanks, Christine. This technology might give us a chance to jump into the deep end of investing, but it's great to have a swim lesson.
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