Surveys are worthless. SmartMoney just released its 2012 survey of the best and worst brokers.

Let’s be honest here. I don’t trust movie reviews, so why would I put stock in a survey of investment brokers?

Part of the problem is that even the best surveys are of limited valued. For example, here are the categories SmartMoney used to rate brokers: commissions and fees, mutual funds and investment products, banking services, trading tools, research, and customer service.

Now there is nothing wrong with this list, per se, except that several categories are completely useless to me. And I suspect they are useless to most investors. For example, I don’t care about banking services. I don’t bank at my broker. And I also don’t care about research; there’s a ton of research available online.

While we can just ignore the rating categories that are of no interest to us, it skews the results. For example, the most important category to me is cost. Yet SmartMoney rated Fidelity as the #1 broker, even though it scored just 3 out of 5 stars on commissions and fees. Apparently its banking services and research are top shelf.

Still, I find it interesting to see how the “experts” are ranking the various brokers. As the internet has taken over, brokers have become more of a commodity, with price being the most significant factor for many investors. But there are some differences beyond price that are worth considering (e.g., Scottrade has offices everywhere, Sharebuilder makes small monthly investments possible at a reasonable cost).

So with my rant out of the way, here are the top ten brokers according to SmartMoney:

1. Fidelity
2. Scottrade
3. TD Ameritrade
4. E-Trade
5. Charles Schwab
6. TradeKing
7. Zecco
8. Merrill Edge
9. ShareBuilder
10. WellsTrade

Here are the details of the rankings (click to enlarge):

This morning I read an article on CNN with the headline, “Seniors clamoring to invest in Facebook IPO.”

Of all the silly articles written about Facebook’s impending IPO in an effort to draw readers to news websites, this one has to be the lamest. So of course I read the article.

It turns out the article’s headline is not lame–it’s completely misleading.

Apparently 79-year old Alvan Sweet told CNN that Facebook’s IPO is “one of the hottest topics” in a retirement community in Boyton Beach, Fla. It’s so hot, in fact, that three (yes, three!) of Sweet’s friends have been badgering Sweet to help them get in on some IPO shares. Sweet, as it turns out, has been investing in IPOs for some time.

But Sweet has no intention of investing in Facebook this week. According to Sweet, recent IPOs like Groupon may rise at first, but then have difficulty maintaining their price. So Sweet ain’t “clamoring” for Facebook shares. And his three friends who do want in on the IPO refused to speak to CNN or identify themselves.

So maybe the article headline should have read, “Three unidentified seniors in south Florida are clamoring to invest in Facebook, but their friend who is an IPO investor won’t touch the social media giant with a ten-foot pole.” Probably too long.

And if ridiculous articles like the one on CNN weren’t enough, Facebook has actually raised the price of its IPO shares (with the press pumping the stock, why not?). This Friday Facebook will begin trading under the ticker ‘FB’ on the Nasdaq. It prices its shares the night before. Recall that I wrote last week about how Facebook is not worth $100 billion. Well now they’ve decided to raise the price of the shares from a range of $28 to $35 to a new range of $34 to $38. I assume CNN does not get a commission.

And that brings me to 11-year-old Jade Supple. The WSJ reported that the IPO “excitement has drawn in fledgling stock buyers such as 11-year-old Jade Supple of Rockville Centre, N.Y., whose father plans to bet money saved to put his daughter through college on Facebook shares, although he has doubts about the price.”

Think about that. Of all the possible investment choices, this poor girl’s father is going to “bet” his daughter’s college fund on Facebook even though he has “doubts about the price.” I hope she pays attention, because this investment could be the best education she gets in a long time.

And for those of you still thinking of buying into the IPO, I’ll leave you with the words of Warren Buffett:

We never buy into an offering. The idea that something coming out…that’s being offered with significant commissions, all kinds of publicity, the seller electing the time to sell, is going to be the best single investment that I can make in the world among thousands of choices is mathematically impossible.

Here are three facts about mortgage applications that at first glance are difficult to reconcile:

Fact 1: Mortgage rates are at historic lows.

Fact 2: Real Estate prices have fallen substantially over the past few years.

Fact 3: The number of mortgage applications over the past 2 months are DOWN.

So what’s going on here? Well, according to the WSJ, part of the problem is persistent unemployment. Rates and prices can be low, but if you are looking for work, you won’t be buying a home or refinancing a mortgage.

But there is a second problem that has persisted for several years–low credit scores. According to Fair Isaac, the creator of the FICO credit score, more than 25 percent of consumers who have active credit files (about 43 million people) have FICO scores of 599 and below. Here’s a chart from FICO Banking Analytics Blog showing the shift over time:

And for most mortgages, a score of 599 won’t qualify you for a mortgage.

Now, we’ve already covered what credit score you need to get a mortgage. But there are still two unanswered questions. First, what credit score do you need to qualify under Fannie Mae’s guidelines (which most mortgages must meet)? And second, even if you qualify, how does your credit score affect what you’ll pay for the loan?

Let’s take a look at both of these questions.

What credit score do you need to meet Fannie Mae’s guidelines?

Fannie Mae publishes a series of matrices setting out fairly complicated rules on pricing loans. These rules include not only credit score requirements, but also loan-to-value (LTV) rules. LTV is important because in combination with your credit score, it can result in higher or lower interest rates and in some cases determine whether you will qualify for a mortgage at all.

Perhaps the most common mortgage is for the purchase of a single-family home. Subject to some exceptions, your credit score must be at least 620 if your LTV is equal to or less than 75%, and 660 if your LTV is greater than 75%. The same guidelines apply for what is called a limited cash out refinance (LCOF).

How does your credit score affect the closing costs of the loan?

This is where things really get interesting. Fannie Mae breaks credit scores into eight categories. For each category, it then provides varies LTVs. For each credit score/LTV combination, Fannie Mae provides what it calls a Loan-Level Price Adjustment (LLPA), which ranges from -0.25% to 3%. This means that depending on your credit score, down payment, and other factors, you could be paying up to 3% more on your loan.

There are several charts published by Fannie Mae showing the various credit score/LTV combinations. Here’s an example of one (click to enlarge):

So what’s the takeaway here? First, as we’ve said many times before, your credit score is really important. A good score of at least 720 (and preferably higher) will save you thousands of dollars in mortgage interest. Second, there is no reason to worry about a “perfect” credit score. The chart tops out at 740.

Third, don’t be fooled by advertised mortgage rates. The ads always show the lowest possible rates. Depending on the terms of the loan and your credit score, however, your rate could be higher. And finally, the Fannie Mae guidelines are extremely complicated. We’ve only scratched the surface here. So if you are in the market to buy a home or refinance, check with a mortgage broker who can walk you through all the rules and let you know the best mortgage rates available for your specific circumstances.

One of the questions I see a lot deals with which financial goal you should tackle first.

Should you pay off your credit card debt first, and then build an emergency fund? Should you save for retirement while you still have school loans? Which credit card should you pay off first?

Yesterday, Deacon from Well Kept Wallet asked the following question in response to my post on the 2012 Retirement Confidence Survey:

I agree with trying to start investing as early as you can but what if you have debt? Shouldn’t you pay that off first?

My first reaction was to look through the archives here to find articles that cover this topic. I found several–

• Should You Sell Investments to Pay Off Credit Card Debt?
• Should you invest in a 401(k), a Roth IRA, or pay off credit card debt?
• Should You Stop Saving for Retirement to Pay Off Debt?
• Save or Repay Debt–That is the Question

One thing that I found interesting is how my approach to this topic has changed over the five years I’ve blogged here at the Dough Roller. Today, my starting point would be to prioritize savings and debt repayment. Let me explain.

Recently I wrote about where you should put your retirement savings. Based on a forum posting over at the Bogleheads, the priority looks something like this:

1. 401k/403b up to the company match
2. Max out Roth IRA
3. Max out 401k/403b
4. Taxable Investing

So let’s add some debt into this picture. Let’s assume the following debts:

1. Fixed rate mortgage at 5%
2. Student loans at 3.4%
3. Car Loan at 7.5%
4. Credit card debt at 18%

Now the picture is not so easy. Still, I think we can come up with a general framework on how to approach this, recognizing that every situation can be different and require a different approach. So where do we begin?

Lower Every Interest Rate You Can

Step one with debt is to get the lowest interest rate you possible can. Can you refinance your mortgage? Even at the 5% in our example, a refi down to 4% may be doable, given the low mortgage rates today.

Can you refinance your car loan? It’s actually much easier than you might think. Most auto refinances can be done online. Finally, can you transfer your balances to a 0% credit card? Credit card rates tend to be the highest as compared to other forms of debt, so getting your interest to zero can save a lot of money.

Where do you start?

Let’s assume that you can’t get your interest rates any lower. Where do you start? If I were in this situation, my first step would be to invest in a 401(k) up to my company’s match. Why? The company match is free money. Even with credit card debt I’d take advantage of my employer’s contribution to my retirement. Some may disagree with me on this one, but it’s just too hard for me to turn away free money.

Once I’ve done that, or if my employer doesn’t match 401(k) contributions, I’d turn my attention to a small emergency fund. For me, I’d start by saving enough money to cover my expenses for one month. I just can’t stand the thought of living paycheck-to-paycheck.

Once I had a small emergency fund stashed in a savings account, I’d tackle my high interest credit card debt. At 18%, the cost is too high to ignore. And I’d do everything in my power to pay of the cards as quickly as possible. (If you’re struggling with high rate cards, check out our series on how to get out of credit card debt.)

Once you get rid of your high rate debt, the choices become a bit more difficult. Some would say pay off all of your non-mortgage debt. But at reasonably low rates, I prefer a more balanced approach.

I would take any extra cash (over and above the minimum payments I had to make on my debt) and put it in equal parts toward retirement savings, debt, and my emergency fund. For the debt, I’d tackle the car loan first because it has a higher rate than the school loans. The school loans would come second. And I wouldn’t begin paying more on my mortgage until I was maxing out my retirement savings and a 6-month emergency fund.

The problem I have with trying to pay off all your debt first is that so many people never succeed. The pay down their debt for a period of time, but then something comes along that causes them to go into more debt.

So that’s how I’d approach Deacon’s question. How do you handle debt and investing?

They say insanity is doing the same thing over and over again and expecting a different result. Tech Buble meet Facebook.

Facebook is on the verge of ushering in the largest IPO ever. FB plans to offer 337 million Class A shares at between $28 and $35 per share. At the high end of that range, and adding in other outstanding shares, you arrive at a valuation just shy of $100 billion.

Last year the company’s net income was about $1 billion.

At a $100 billion valuation, Facebook’s price-to-earnings ratio would stand at 100. In other words, at current earnings it would take investors 100 years to earn back their investment.

Google stands at a P/E of 18.

Apple’s P/E sits at 14.

The case for the valuation is that Facebook’s growth will be nothing short of phenomenal. In other words, investors are betting that Facebook will grow into its valuation.

Such a theory is not unprecedented. Google’s P/E at its IPO was 195! Google’s stock was priced at $85 at its IPO, soared to $600 in 2007, fell to the mid-$400′s in 2009, and today sells for about $600. My guess is that if you bought at the IPO and still own the stock today, you’re pretty happy.

The same could happen to Facebook. But it’s not a smart bet for several reasons.

First, Facebook’s momentum has already started to slow. During the first quarter of 2012, its revenue grew at a 45% pace as compared to a year ago. That’s growth most any company would love, but a far cry from the nearly 90% growth it enjoyed a year earlier. At its profit actually fell 12% from a year earlier.

Second, 85% of its revenue comes from advertising. If Facebook is going to grow into its valuation, it will need to expand its other revenue streams. As you’ll see below, its growth in the U.S. has already started to slow, where a lot of advertising dollars are spent. And its advertising platform just can’t compare to Google’s.

We use search engines to find and buy stuff, so ads are a natural fit. Facebook is still about connecting with friends and family. Is there a place for advertising on Facebook’s platform? Of course. Does it justify a $100 billion valuation? No way.

Third, Facebook is running out of potential customers. According to its S-1 filed with the SEC, it has about 900 million users. The same filing tells us that there are about 2 billion internet users worldwide. If they can double their users, they’ll have to expand to another planet to find more growth.

Facebook has already saturated markets like Chile, Turkey, and Venezuela where FB estimates penetration rates of greater than 85%. And check out this chart taken from its S-1:

The overall growth of monthly users is impressive. But notice how growth has already started to slow in the U.S (second row graph on the left). Consistent with these charts is that Facebook’s revenue from outside the U.S. has been growing. But the saturation in the U.S. does not boad well for the scale FB needs to achieve to justify its valuation.

Still, it will no doubt be a feeding frenzy when the opening bell rings. Paul R. La Monica of CNN The Buzz fame put it best–

Of course, none of my skepticism will make a difference when Facebook starts trading. The demand for the Facebook IPO will probably be so hot that investors will buy first and ask questions later. The $5 billion worth of stock Facebook plans to sell is a tiny amount.

“Given the small float and scarcity factor, everybody will want a piece of the action,” Loughran said.

But mark my words: Valuations still matter. Eventually, Facebook will have to trade at a price that’s more in line with its peers.

But if you are just dying to buy Facebook shares, there’s good news for the small investor. Lat last Thursday Facebook added E*Trade to its list of underwriters. If you want Facebook IPO shares, E*Trade is your answer.

And speaking of Facebook, do you mind heading over to the Dough Roller Facebook page and giving it a like? FB might not be worth $100 billion, but 900 million users is nothing to sneeze at!

The Employee Benefit Research Institute recently released its 2012 Retirement Confidence Survey (pdf download). It’s not a pretty picture.

The survey covers a lot of retirement issues, including confidence you’ll have enough to retire (most aren’t so confident), what age you think you’ll retire (in 1991 11% said 65; in 2012 it jumped to 37%), to why people retired when they did (more than half were forced to retire for various reasons). What interested me the most, however, was the rate at which people are currently saving for retirement. Actually, it saddened me more than anything else.

Here are the stats:

• Only 66% of workers report saving for retirement (down from 75% in 2009));
• Even among retirees, only 68% have ever saved for retirement;
• The percentage of workers who are currently saving for retirement is just 58% (down from 65% in 2009));
• Sixty percent of workers have saved less than $25,000
• Thirty percent of works have less than $1,000 saved

It’s the total savings that concerns me the most. Here is a chart from the report showing the amounts saved by year:

If you’re reading this and either aren’t saving for retirement or saving enough, here are some quick tips–

1. If you have a job with a 401(k), start saving today. Even just $25 a month is a step in the right direction, and you’ll miss the money a lot less than you think (remember, it’s before tax savings so your take home pay won’t go down as much as you think).
2. If you don’t have a 401(k) option, start an IRA. You can open an IRA at Betterment for free, get a $25 bonus, and save as little as $25 a month. And it’s easy to set your investing options and let Betterment do the rest.
3. If you think you can’t possible save anything, check out my 99 Painless Ways to Save Money. It’s a eBook you get for free when you sign up to my newsletter (which is also free). You can probably save more than you think!

Recently Ally Bank released two mobile phone applications. The apps, designed for the iPhone or Android phones, are a big step into mobile banking for Ally.

Frankly, Ally Bank has been behind the curve on its move toward mobile banking, but the Ally Mobile Banking and Ally ATM and Cash Locator apps move it in the right direction. Here are the details.

Ally Mobile Banking App

The first app is the Ally Mobile Banking App. It’s a typical banking app that offers account holders secure access to their accounts from a smartphone. If you have multiple Ally accounts you can monitor all of them with the app. Here are the current available features:

• Check balances and search transactions
• Transfer money between Ally Bank accounts
• Search for ATMs and cash back locations

With this being a new app it looks like the functions are pretty basic. However, Ally says it will be adding the following functions in 2012:

• Transfers between Ally accounts and non-Ally accounts
• Pay bills
• Make deposits using your phone’s camera
• Pay people via your phone (Ally cals this feature Popmoney)

the Popmoney feature and transfers with non-Ally accounts could put the bank at the forefront of mobile banking.

Ally ATM and Cash Locator App

The second app up is the Ally ATM and Cash Locator App. This app is taking a unique approach by showing all ATM machines (Ally doesn’t have physical locations) and retailers that offer free cash back when making a purchase. To understand this approach, you need to know one thing about Ally Bank–it charges no ATM fees.

Not only does Ally bank waive ATM fees at ANY ATM, but it also reimburses account holders for ATM fees charged by other banks. So you can withdrawal your money anywhere. And that’s why Ally’s new app shows all ATM locations near you. One nice perk Ally offers their bank debit card customers is they don’t charge them ATM fees even when they aren’t using an Ally ATM. It will help anyone quickly fine over 400,000 ATMs nationwide and thousands of retail locations that offer cash back.

For more details visit Ally Bank’s website.

As I mentioned earlier this week, I started investing in individual stocks about three years ago. While I consider myself a passive investor, I’ve come to believe that smart passive investing can include individual stocks and industry-specific ETFs.

Of course, it’s one thing to invest in individual stocks and another thing to actually make money investing in individual stocks. So today I’m publishing my first investment portfolio update. In this update, I’ll show you exactly how my investments have performed, both good and bad. I’m not including my mutual funds, which are still the bulk of our portfolio. The idea here is to see how I’ve done picking individual stocks.

My hope is that these updates will accomplish several things. First, they add a level of transparency. It’s one thing to write about personal finance and investing everyday. It’s another thing to show the world exactly how you’ve done. Second, it helps me stay accountable. It may seem odd, but blogging about personal finance keeps me so busy that sometimes I ignore my own finances! That’s not smart, and these updates will force me to stay on top of my investments.

Finally, I’ll share what I’ve learned since the last update. Investing always involves learning. You not only learn each day about the mechanics of investing, but you also learn a lot about yourself. Will you panic in a down market or get manic in an up market? It’s hard to know until you’ve experienced it. But the lesson can be invaluable.

So with that, let’s get started.

SEP IRA

Three years ago I opened an SEP IRA at Scottrade. I picked Scottrade because its costs are low and they have an office near where I work. I don’t go to their office often, but it’s nice to know that I can when the need arises. I’ve been happy with the account, although the user interface could use some work.

Over the past three years I’ve purchases 4 securities: Apple, Cisco, Citi and ITB (a housing sector ETF). I add to my investments every April when I make my SEP IRA contribution for the previous year. So this past month saw a sizeable increase, which I used to buy more Citi and ITB.

Here, are the details of my investments in my SEP IRA:

Two of these investments, Apple and Cisco, I purchased one year ago in April 2011. I couldn’t be happier with their performance. In one year Apple is up more than 70% and Cisco is up more than 18%. Of course, that’s just one year. They could both be down next year. And as I’ve written before, the higher prices are a real drag when you reinvest dividends.

ITB, which I purchased in both April 2011 and 2012, is up about 16%. I purchased ITB because sooner or later the housing market will rebound. From an investment perspective, I really don’t care when. With Citi, I made a bet that the bank would recover and do well over the long run. It’s down about 3% for me on purchases made over the past three years. I continue to believe it will do well over the coming years. Perhaps not as well as some of its peers (e.g., Wells Fargo), but we’ll see.

Vanguard Taxable Account

I started investing in dividend paying stocks in my Vanguard account in 2011. I got fed up with the lousy yields on “high yield” savings accounts and government bond funds. While I still invest in bonds, of course, I decided to move some of our portfolio to well respected dividend paying stocks (with the exception of Berkshire, which doesn’t pay dividends). Here is the status of these investments:

I plan to add to this account in 2012. I want another dividend paying stock in an industry not covered by my other stock holdings. I’m still working on what to buy. If you have any suggestions, leave a comment below!

Betterment

Betterment is a company that makes investing really easy. You simply pick how much of your money you want invested in stocks and how much in bonds, and Betterment does the rest. The money you have with Betterment gets allocated to a number of low cost ETFs. Betterment is a great way to get started because you can begin investing without a lot of money.

As more of an experiment, I opened an account several months ago with $250. Betterment added $25 to my account as a bonus (an offer they still have if you follow this link). At the time, I was not happy with the fees Betterment was charging, so I didn’t add to my account.

Recently, however, Betterment significantly lowered its fees, added an IRA option, and provided more features (you can read about the changes here). So I began an automatic investment of $100 a month. It’s not a lot of money, but one thing I hope to show those just starting out is how even a little money, invested each month, can really add up over time.

For my Betterment investment, I’ve allocated 100% to stocks. The following image is a screenshot from my account showing my exact asset allocation:

So how have my Betterment investments performed? Frankly, not so great. I’m up just 0.3%. But with truly passive investing, this is to be expected from time to time. Furthermore, this issue isn’t Betterment. That’s just the performance of the underlying ETFs Betterment uses. Still, I’ll be keeping an eye on the performance over the coming months. Here’s a screenshot form my account showing my exact performance (as of April 29, 2012):

LendingClub

Investing in LendingClub notes has been a bit of a hobby for me. I’ve enjoyed trying to figure out how to make above average returns. And frankly, it’s a good feeling to invest in the lives of people building businesses, consolidating debt, or just trying to improve their lives.

If you’re new to LendingClub, check out my article on how to boost your LendingClub returns. I wrote that article when my returns were languishing around 7.5%. After implementing the strategies I describe in that article, my returns jumped to 9.07% in just six weeks, as I described in this update article.

So the question today is how have my LendingClub notes performed since my last update. The short answer is that they’ve done really well. They’ve gone from 9.07% in my last update to 11.52%. Here’s a screenshot from my account:

As you can see from the screenshot above, I have almost $1,000 in cash in my LendingClub account. I’ll be looking for notes on the secondary market to invest in over the next month. For more information on investing or borrowing, check out LendingClub’s website.

So that’s it for this update. In future updates, I’ll look more closely at how I pick stocks and how these investments fit into our overall portfolio.

Like the formula for Coca-Cola , the FICO credit scoring formula is a closely guarded secret. The Fair Isaac Corporation, however, does give us a glimpse into the secret sauce from time to time.

For example, Fair Isaac has disclosed what factors go into its scoring model and the weight to be given each factor:

While these factors are helpful, they leave a lot of information out. For example, how does a late payment affect your score? Is it better to have a zero balance on your credit cards? And how exactly will credit inquiries lower your FICO score?

Well, I found some answers to these questions over at the myFICO forums. Apparently, Fair Isaac released the following chart about the FICO formula:

It took me some time to unravel this chart. But if you spend some time with it, you’ll see that it’s packed with some useful information, particularly if you are trying to improve your score.

For example, if you have a late payment on your record, the biggest impact to your score occurs in the first five months. In month 6 you’ll see a 5 point increase, and by month 12 another 10 points. You get the full benefit of clean record after 2 years.

Another thing I found interesting about this chart is the impact carrying a credit card balance has on your score. You get the biggest boost to your score if you carry a balance ranging from $1 to $99. If you have a zero balance, your score actually takes a 10 point hit. Go figure.

Finally, this gives some insight into how credit inquiries affect your score. With four or more credit inquiries, your score can drop 50 points.

Keep in mind that the actual impact on your score depends on many factors not reflected in this chart. And if you want to check your score, there are several free ways to get your credit score.

When I started investing 20 years ago, I was terrified of the idea of investing in individual stocks. My parents never taught me about the stock market, and all that I knew was what I read in books. So when I started investing, I invested in stock and bond mutual funds.

I did so poorly at first. An “advisor” at a local bank with a brokerage arm steered me into a few expensive mutual funds with front loads (fees you pay just for the privilege of giving a mutual fund your money). The funds were actively managed, not index funds. That meant that on top of the front load, I was also paying a lot in fees each year so that a manager could pick stocks the fund would buy. The fund never beat the S&P 500. So basically, I paid a mutual fund a ton of money to underperform the market.

It didn’t take long for me to conclude something was very wrong with this picture. With the help of some great books, like Rick Ferri’s All About Asset Allocation, I concluded that passive investing was the best way for me to build wealth in the stock market. This lead me to a fanatical attack on fees and managed funds. I moved most of my money to low cost index funds. You can read about my views on mutual fund fees, the hidden costs of mutual funds, and how costs can eat away at your retirement.

As I learned more about the market, I eventually concluded that picking individual stocks was like chasing fool’s gold. You may be able to beat the market for a time, but like the great Bill Miller (who’s Legg Mason fund beat the S&P 500 for about 10 years and then cratered), eventually your luck will run out. So I stuck with mutual funds, most of them index funds.

Today, my perspective has changed significantly. While most of my investments are still in low cost mutual funds, over the past two years I’ve started investing a portion of our money in either individual stocks or industry-specific ETFs. There are two big reasons why I’ve taken this approach, which I’ll discuss in a moment. But first, let’s talk about passive investing.

What is passive investing

Passive investing is about a lot more than index funds. In fact, I’d argue that passive investing is less about what you invest in than how you invest.

For example, I know plenty of people who invest all of their portfolio in low cost index funds. So far, so good. But when a bear market comes along, they sell their index funds and stash their money in bond funds because it makes them feel safer. When the market is going up, they do the opposite. This is not passive investing.

On the contrary, I’d argue that you can be a passive investor by picking a single stock and sticking with it through good times and bad. You’d have to pick the right stock in a company that is very diversified, like Berkshire Hathaway. But to me, such an investor would be far more passive than one who jumps in and out of index funds as the market rises and falls.

Why individual stocks have a place in a passive investor’s portfolio

As I’ve had more experience investing and now manage a much larger portfolio than I did 20 years ago, my views on investing have changed. Today I own stock in several companies (Apple, Cisco, Citi, Verizon, Pepsi, Berkshire) and an industry-specific ETF (ITB-Housing). I’ve made this move for two reasons.

First, in taxable accounts, you have far more control over capital gains with individual stocks than you do mutual funds. Unless I sell some of my investments, I pay no capital gains tax. While you can invest in tax efficient mutual funds, you still don’t get the same level of control. The same is true for dividends.

If you have $10,000 to invest, the tax issue may not matter to you right now. But as your portfolio grows to 6 and even 7 figures, taxes will become huge. And that’s particularly true if you are in one of the top tax brackets.

Second, it’s cheaper to invest in individual stocks than it is to invest in mutual funds or ETFs. With ETFs and index funds, you can find some really inexpensive ways to invest. Vanguard’s S&P 500 fund, for example, costs just 5 basis points a year (just $5 for every $10,000 invested). But every dollar counts, and with individual stocks there are no mutual fund management costs. You do have to pay a brokerage fee when you buy the shares, but the best online discount brokers cost just a few dollars per trade.

In my case, I’ve been able to lower my overall expense ratio from 48 basis points to just 28. Twenty basis points (.20%) may not seem like a lot, but over a lifetime of investing those costs add up to a significant amount.

But what about diversification?

I was nervous when I first starting investing in individual stocks. But over time I’ve come to really enjoy it. I still have the vast majority of our money in low cost mutual funds and ETFs. But the portion I have in individual stocks has become an important part of our investment plan. Our costs are down, and our taxes are down.

All of that being said, investing in individual stocks is not for everybody. For beginners, I’d stick with low cost mutual funds, ETFs, or something like Betterment (an excellent option that has really come down in price).

If you’re a passive investor who still buys individual stocks, leave a comment to let us know why you’ve taken that approach and how you’re doing. If you think buying individual stocks is a big mistake, we’d like to hear from you, too!