I do NOT recommend picking individual stocks. However, if you are going to ignore my advice– I admit I do for a small portion of my portfolio– then I want you to at least think about investing in individual companies correctly. You also need to track your performance against an appropriate benchmark like the total stock market. This can actually be pretty easy with this simple trick.
Make a ‘benchmark’ account
First, keep your stock-picking account separate from your other investments in its own separate account. Next, open another brokerage account of the same type as your ‘benchmark’ account.
Use a reputable brokerage like Vanguard— not scammy garbage like Robinhood– for God’s sake. Most people do and should use taxable (non-retirement) investment accounts for both your individual stocks and benchmark accounts. This keeps you from monkeying around with your retirement money.
A tip on avoiding taxes while owning stocks
I use a portion of my Roth IRA for my individual stock investing to avoid paying dividend or capital gains taxes when I trade. This also makes it easier to compare performance since I don’t have to subtract taxes from my investing results. Keep in mind that you can’t touch your Roth earnings until you’re 59.5 if you choose to go this route. Make sure you mentally separate this money from what you actually need to retire.
Keep the money flows in and out of both accounts equal
Now, fund each of these accounts equally. If you start out with $10,000 in one, put $10,000 in the other at the same time. With the benchmark account, put all of the money into whatever the appropriate benchmark is for comparing to the types of companies you’ll be investing in. If you are going to be picking mostly US stocks, then invest your benchmark money in a broad US index like the Vanguard Total Stock Market index fund (ticker: VTSAX), or its ETF (ticker: VTI.) Make sure you automatically reinvest dividends & capital gains into your benchmark fund (another reason to use Vanguard since they let you do this.) Your two accounts will look like this at the beginning:
In your stock-picking account, start buying and selling or holding cash as you like. Over time, your benchmark account will grow with the market, and your stock-picking account will grow (or shrink!) depending on your results. Whenever you want to compare your relative performance, just look at the two balances and see which is higher.
Let’s pretend that after two years, your stock-picking account has grown to $15,000, and your benchmark to $12,000:
Make sure that whenever you add or remove money from one account in the future you do the same with the other at the same time. Ideally you would also log these money moves in or out of your accounts in a spreadsheet so that you can compute fancier comparisons like your average annualized percentage returns (using the XIRR formula.)
Even if you can’t be bothered to compute annualized gains, you can at least say whether or not you’re beating the market and by how much in absolute dollars and as an absolute percentage difference.
Using less money for your benchmark
You don’t technically have to use equal dollar figures in your benchmark, although it’s the easiest way. Instead, you might do 1/10th the amount in your benchmark. E.g.: $10 K in your stocks account and only $1,000 in your benchmark fund. However, you’ll need to remember to multiply your benchmark fund by ten to compare the two balances, and doing the same math for any money that goes in our out, including for taxes.
Accounting for taxes
If you use an individual account, you should try to account for taxes. The best way to do this is to just estimate your tax burden from the investments each year when you file your taxes. Use your 1099-B and 1099-DIV forms to see how much of your capital gains and dividends are attributable to your benchmark and your stock-picking accounts, then subtract the respective tax burden from each account at tax time.
Lazy tax accounting
Of course, if you use your Roth IRA like I do, you don’t have to do this because you don’t owe taxes on that money. If you’re using a taxable account and are lazy, you can just pretend that the dividends from your benchmark fund roughly cancel out your dividends from your stock-picking fund, and just focus on subtracting any capital gains taxes you generate from selling your stocks.
Keeping yourself honest
Comparing your investment results to what you could have received from a low-fee index fund is an essential step in picking stocks so that you can tell how you’re doing vs the market.
I hope the trick above makes it easy and convenient for you to keep tabs on your performance over time. Many happy (investment) returns!
