Stock Picking Shouldn't Be Allowed for Everyone

Markets this year are putting the risk in risk premium. Any asset that typically pays more than a low-risk bond (or zero return) will expose you to losses from time to time, and that happened a lot last month. But that’s the deal: Risk is the cost of potentially higher gains. Some investors take more risk than others. If you face bigger losses than you can afford and don’t get an overall higher return out of it, you need to rethink your investing strategy. And if that describes you, then odds are you own individual stocks. As volatility comes back and the Memestock era ends, it's worth asking: Should retail investors even be allowed to own individual stocks?

That may sound extreme. After all, what embodies American capitalism better than buying a piece of a business you admire, or respect, or just think will make you rich? Except we set up guardrails and warnings when it comes to many other aspects of our lives, from data protection to buying a mattress. Yet taking on more risk than necessary, which is the essence of individual stock investments, is not only unrestricted, it's sometimes cheered on.

There's an important distinction here between owning stocks and owning shares in particular companies. We should encourage stock ownership, and I believe Americans should be taking more risk. Risk in your portfolio is, for most of us, the only way to grow wealth. Only about 50% of Americans own stock and this contributes to wealth inequality. But there is a good way to take risk and a not-so-good way. The economist who taught me finance often says owning an individual stock is like owning a car muffler. Its value comes from its role as part of a larger system, which in finance translates to a good diversification strategy.

Between the rise of online trading platforms and workplace 401(k)s, more Americans own stock than ever before, yet we never bothered to educate people on some of the basics. When you invest in the stock market you face two kinds of risk: idiosyncratic — the risk a single stock will rise or fall; and systematic — the risk the whole market will rise or fall.