It’s better to own individual stocks to accumulate wealth long-term than to own mutual funds and ETFs indexed to the stock market’s return.

Wait a minute. Doesn’t that go against the grain of those studies that show active investment strategies don’t beat the market over time?

Yes it does. But, done right, individual stock picking can be the better option.

This according to Austin Root of Stansberry Research, who oversees the company’s The Capital Portfolio, which gained 35 per cent in 2020.

Root presents his case for stock picking, plus what he learned from two legendary investors that he worked for, in this question and answer session with a colleague.


by Austin Root, Lead Editor, Stansberry Research

I wrote recently about the best way to invest your wealth for long-term growth is to buy individual stocks and not to own mutual funds or exchange-traded funds (ETFs).

First, I think you really can outperform the market when you do that. That’s because you don’t have to pay the fees.

Even if the fees are low for the ETFs, they’re not generally low for mutual funds.

It pays to be diversified, but only up to a point. If you own 500 stocks, no one stock can be really that great for your portfolio. But in The Capital Portfolio, we own roughly 20 to 30 names.

Any one of those stocks are really powerful and important. And they can be impactful to your overall portfolio.

The other thing about it is, when you own individual stocks, you have a better chance of knowing what you own and therefore, why you own them.

And therefore, you’ll make better decisions when things get crazy.

For example, when the world was still trying to figure things out in early 2020, I didn’t want to be allocated to the overall market.

I trust our research, and I really believe in what we’re doing in Stansberry Portfolio Solutions. You could still pick out and identify opportunities that were exciting.

So we identified gold and some other world-class companies that had sold off, and we bought those.

For me, when you own individual stocks, I think of it like you own part of the business. And doing that makes you an overall better investor.

I wrote an essay about why it’s time to stop renting your stocks and start owning them with a simple idea.

When you go out and rent a car or rent a beach house, you do a lot less work on making sure those are the right things for you than if you go buy a car or you go buy a house or a vacation house.

If you do that, you’ll make better decisions over the long run.

Corey McLaughlin (CM): I want to ask you about “risk management”. How do you go about crafting a portfolio itself with risk management in mind?

Austin Root (AR): It’s a careful balance. Mentors of mine remind you that so much of the market’s gains and so much of your portfolio’s gains will come from your big winners.

So you need to balance risk management – in particular, the risk of any one portfolio position – with the problem that:

  • Too often investors trim their flowers and let the weeds grow.

It’s something that I hope people can learn from me and watch as we’re doing this within our Portfolio Solutions.

For example, Sea Limited (NYSE:SE) was up more than 300% before we started to trim it.

But then, it got to be such a large percentage of the overall portfolio that we needed to start pairing that down, even though we still have a favourable outlook.

CM: What are the problems you’ve seen investors having when they manage their own portfolio?

AR: In speaking with individual investors and based on my prior institutional investment experience, two common problems arise.

Oftentimes, folks have portfolios that are too diversified. They just have far too many positions.

Or they aren’t diversified enough where, maybe by virtue of working for a company and getting that stock in their retirement plans year after year, they’re too concentrated in one or two very large positions.

The goal is to not do either one of those.

If you’re over-diversified, that hurts your gains or your return potential. And if you’re under-diversified, you run the risk of any one of those stocks or situations really hurting your performance.

So in Portfolio Solutions, not only do we make sure that no one position or no couple of positions are too large, we also look at something called “factor risk.”

We want to make sure that no one risk factor is too large in our portfolio.

So for example, China. We want to make sure our China exposure is not too large. And we also want to make sure that we don’t have too many banks or too much commodities exposure.

We’re trying to manage risk and the portfolio across a couple of different vectors

CM: You’ve worked with, and at, some of the biggest investment firms around. Where was your formative experience? In other words, when did you get fully immersed in investing and learn a lot of what you’ve learned?

AR: After going to business school, I first worked in the public markets for Steve Cohen (Point72 hedge fund, New York Mets owner). And whereas people talk about the “elevator pitch,” Steve had the “chair swivel”.

In his office, he was sitting in front of 16 screens. He would turn his chair to you if you had to pitch something to him. And if you didn’t excite him or he got bored on it, even in mid-sentence, he would just swivel his chair back to his monitors and start trading.

I observed this enough times to realize what he wants to understand is what matters most to the stock and for you to lead with that.

You can get bogged down in tons of stuff, but he was the master at figuring out what matters most of the stock – both in the short term and the long term – and figuring out if you can develop an analytical, informational edge about that. That was really helpful for me.

From Julian Robertson (at Tiger Management), I learned a lot.

This was a guy who could do both – understand the micro story, he was a great individual stock investor over his career – but also understand the macro and understand that you must get both right, that you can be right on the stock, but wrong on the macro situation and just get run over.

He actually highlights being bearish and “short” housing in 2006, 2007, and 2008 as his best trade ever.

Even though he’s this world-class legendary stock investor and hedge-fund investor, he routinely said that that was the trade he was most proud of and thought it was his best trade.

That really helped me because, up to that point, I was focused on the micro.

As an analyst, you’re building up models and trying to know everything you can about this one company.

But it’s really helpful as a portfolio manager to take a step back and understand that it’s not just that one tree, it’s the entire forest that matters.


Image source:

Related stories: Four Mission Critical Steps to Take Before Investing