The New Wave in Stock-Picking? Do-It-Yourself

Percy Bolton has been a financial planner in Los Angeles for 20 years, which makes him an old-timer compared with most people in the financial services business today.

And what Bolton increasingly hears from his clients, he says, is a distinct change in tone from previous years. Many, he says, are dissatisfied with what has been the foolproof way to wealth in the 1990s: simply buying and holding diversified stock mutual funds. Instead, Bolton says, many of his clients now want to be involved with individual stocks as well--researching them, picking them and trading them.

“I see clients who never invested [directly in stocks] starting to do their own stock selection,” he says. Many, he adds, are accomplished, do-it-yourself-type professionals in their own industries who now believe they can become accomplished at stock-picking as well.

A growing amount of anecdotal evidence suggests that Bolton’s clients are part of a new wave that is beginning to make its presence felt in this bull market.

The conventional wisdom, backed up by statistics kept by the Federal Reserve, is that individuals have, on balance, been liquidating their direct holdings of stocks over the last two decades in favor of indirect ownership, via mutual funds.

And there’s no question that the stock market’s tremendous run in the ‘90s has helped feed--and has been fed by--the funds’ boom.

But last year, stock funds’ net new cash inflow of $231 billion, while a record, was up just 4% from the $222-billion inflow in 1996.

Contrast that growth with the number of new investment clubs registered with the

National Assn. of Investors Corp., the Royal Oak, Mich.-based organization that is the umbrella group for such clubs. New clubs formed in 1997 totaled 7,501, lifting the club count nationwide 28% from 1996 to 34,021 by year’s end.

The total has continued to rise this year, to a record 35,947 clubs as of March 4, the NAIC says.

Most investment clubs are formed by friends, co-workers or relatives (average number of members per club: 17) for the express purpose of researching and purchasing individual stocks for a group-owned portfolio--a mini mutual fund, in effect.

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To be sure, the clubs’ investment power is no match for the stock fund industry, which holds approximately $2 trillion in U.S. shares today. But the funds’ power also tends to be exaggerated because of all the publicity the industry gets.

That $2 trillion is, in fact, less than 20% of the value of the U.S. market overall.

While the funds’ active trading makes them an important influence on the market at the margin (i.e., in day-to-day action), the fact is that 80% of stocks’ value is in the hands of others, notably private and public pension funds, bank trust funds, foreigners--and individual investors who own shares directly.

Why might more investors be interested in building their own stock portfolios, as opposed to relying on mutual funds? Consider a few of the factors that are pushing people toward direct ownership:

* Heated competition among deep-discount brokerages has sent commissions for buying or selling stocks as low as $8 a trade when done over the Internet. That price is so cheap that it makes trading costs almost an afterthought.

And buying an individual stock doesn’t involve sending away for a packet of background material first--as is required when first-timers buy a mutual fund.

* The cut in the top federal capital gains tax rate last year, from 28% to 20%, has focused more investors on the merits of being able to control their capital gains situation. When you own individual stocks, you’re in total control--you don’t realize a gain, or a loss, until you decide to sell (as investment legend Warren Buffett often reminds people).

By contrast, mutual funds must distribute to shareholders virtually all of their realized capital gains every year. Shareholders have no control over the timing of those gains payments, nor can they have much influence over managers’ trading decisions.

* Increasing volatility in the market since 1996, while making it more likely that an investor can lose a lot of money trading individual stocks, also makes it more likely that some can win big, as stocks gyrate in wide ranges.

In particular, the herd instinct that causes institutional money managers to flee a stock at the first sign of bad news has given individuals many opportunities to successfully bargain-hunt over the last two years--as the rising tide of this bull market has eventually reignited many short-term losers, at least among blue chips.

* After seven years of mostly higher stock prices overall, making money in the equity market seems like a sure thing. It isn’t, of course--but it no doubt feels that way to many investors.

Owning stocks via mutual funds has been lucrative for most investors, but let’s face it--fund ownership is pretty boring at heart. Success breeds confidence, and eventually over-confidence.

Indeed, Wall Street’s bears see the trend toward more individuals owning stocks directly, as manifested in the explosion of investment clubs, as a sign that the bull market has reached a dangerous, speculative stage--the last gasp, as it were.

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That is, of course, a typically condescending Wall Street attitude toward small investors. To say that individuals can’t succeed with stock portfolios they research and build themselves is a ridiculous blanket statement, and it’s no more true than to say that most professional managers are great stock pickers. (Most aren’t.)

Many investors may not totally understand the risks they’re taking with individual stocks, and they may learn the hard way. But learning with individual securities is the natural progression for many people who have cut their teeth on mutual funds--and who, for some very good reasons, may be growing disillusioned with the funds.

Will a new wave of direct participation in stocks by individuals help prolong the 1990s bull market? Who knows--but it certainly can’t hurt the trend.

Tom Petruno can be reached at tom.petruno@latimes.com

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Stock Do-It-Yourselfers

The number of investment clubs nationwide has skyrocketed in recent years, as more individuals have come together to research and invest in individual stocks. Number of clubs at year’s end each year, and latest, in thousands:

Latest: 35,947

Source: National Assn. of Investors Corp.