Are Individual Stocks Too Risky?

09/29/2011 6:30 am EST

Focus: ETFS

In this current environment, investors are looking more at the macro picture, says IndexUniverse.com’s Matt Hougan in this exclusive interview with MoneyShow.com, because picking individual stocks is more difficult and carries a higher risk.

Matt, back in the 1990s, when people were investing—the retail investment boom of the 1990s—it was really mostly about individual stocks. Wasn’t it Cisco (CSCO) and Amazon (AMZN) and the great stocks of that era?

It was really all about finding that hot stock and riding it and making a fortune. But, now, you say things have changed a lot in the way individuals invest.

I think that’s absolutely true. Now, people are looking more at macro economic factors. They’re talking about, should I overweight China, should I overweight India, should I overweight technology as a whole. I think the single stock, particularly in this market environment, is much less important than what’s going on at those big-picture macro levels.

Now, do you think the reason for that is that people realize that it’s just very difficult or very risky to put together a portfolio of individual stocks, because you don’t know what’s going to happen in any individual company?

I think that’s absolutely true. That’s not to say it’s easy to know what’s going to happen in China, right, but really getting an edge on what’s going to happen in Cisco for an individual investor is absolutely impossible.

But you can read the newspapers and have a pretty good view that the long-term outlook for something like China is good, and you might want to allocate to that space. I think it’s a smarter way for most people to invest.

Or, let’s say you have, you know, rather than investing in a hot social networking company, you invest a technology or even Internet ETF, and you do get some diversification in case one company really comes in with a bad quarter.

That’s absolutely right. You do get a safety benefit. You eliminate any corporate-specific risks.

I mean, we’ve seen individual companies blow up. It happens all of the time, and at least by investing the sector, you get access to the theme, which is really what you want.

So basically, I mean, a lot of people, it seems to me from my experience, like to buy individual stocks to play a theme. You know, I’m going to play the growth of the Chinese consumer or the emergence of social networks or something, and I’m going to buy this stock to play that...it’s basically a story.

That’s correct.

So do you think an ETF that captures that will satisfy people’s needs to tell stories to themselves when they invest?

Oh, I think so. I think it’s just a different kind of story. Even you look at the media, if you look at Bloomberg or CNBC, it used to all be chatter about these individual stocks. Now, it’s chatter about stories.

I mean, the story right now is the possible collapse of the European financial system. You could either sell SocGen, or you could sell exposure to Europe.

SocGen. So Societe Generale Group (SCGLF).

Exactly. So you could pick one company. But you don’t know if and how it’s going to hit that individual company.

But you could put options on European banks or something like that.

Exactly. And by taking that bigger picture, you diversify your bets. You have a better chance of executing on what you’re trying to get at, which is that there is risk in the European financial system.

So this all comes down to the ability of individuals, and I guess professionals, to really find winning stocks consistently, and all of the research shows that people just can’t do it—not even mutual-fund managers who get paid to do it.

That’s absolutely true. Well, I mean, people focus their whole lives on picking out intricacies of these individual stocks. The idea that you as an investor could do a better job at that, I think, is very challenging.

You’ve got to get your asset allocation right. You’ve got to get your big themes right. And that’s where the bulk of returns come from, anyway. The research also shows that sector and country returns vastly overweigh single stock selection.

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