If Only…
If you pay any attention to stocks you’ve probably had a few “if only” moments:
If only I bought shares of Apple in 1994 ($6 a share pre-multiple splits).
If only I bought Google in 2004 (up 4000% since then).
If only I bought Tesla in 2010 (from $20 to $240 in 4 years).
Anyone paying casual attention to what is happening in the market can’t help but feel the temptation of companies with soaring stock prices. The media talks about these stocks incessantly so it’s hard not to feel surrounded by missed opportunities.
I know a half dozen investors who have achieved riches from buying the right stock at the right time. You might know someone too. Talk about rubbing salt in a wound.
But that’s six people out of thousands of investors I know. And none of them did it twice; probably because very few companies have supplied life changing returns that lasted over the previous 20 years.
In 2013 over 200 companies went public. There may or may not be one in there that takes off. It’s a given most won’t, and at least some will fail.
Anecdotal tales of professional managers beating the market, let alone phenomenal returns on one stock, are extremely rare. This serves as a reminder that the potential reward of concentrating wealth in a few stocks is exceedingly risky - and potentially devastating.
What makes individual stock investing so risky?
The extra risk that picking individual companies brings to an investor is called business risk. Facing facts, no one can predict when a specific company is going to make a mistake or be hampered by anything from unforeseen costs to legislation to the weather. We also can’t predict when or how a competitor will unveil something that debilitates other players.
So placing a bet on one company instead of buying all of them greatly increases the chance of underperformance. The good news is you can diversify away business risk just by owning the broader market. The bad news is you have to quit speculating on individual companies to do that.
As financial author Ron Ross writes in his book The Unbeatable Market:
‘Firm specific risk (diversifiable business risk) is the prime example of uncompensated risk. Insofar as securities markets are efficient, there is no payoff for taking the risk specific to individual stocks. Virtually every market beating strategy involves uncompensated risk. It would be difficult to overstress the importance of this issue.
Investing in individual stocks exposes you to at least three times as much risk, but with only the same expected return, as investing in a passive index. The only way to make excess returns on individual stocks is by consistently identifying mis-priced stocks, and that can’t be done in an efficient market.
There’s a world of difference between a temporary loss and a permanent loss. The money you invest in an individual stock can go down and out. Not so with a diversified portfolio.
The highly important, practical implication is this: when you invest in an individual stock you take a risk for which you get nothing in return. That’s the essence of uncompensated risk.’*
Uncompensated risk assumed by picking individual company stocks is a great description for what happens in Vegas: It’s gambling, not investing. So if you find yourself tempted by “if only” moments remember this:
If you are invested the Wiser way, you were buying Apple in ’94, and Google in ’04, and Tesla 4 years ago.** And you still own them now, without betting the farm.
The wealthiest of the wealthy have amassed their positions by methodically and prudently maximizing their return for the risk they are taking, not by maximizing their risk in exchange for a return they hoped to get.
Stay wise, my friends.
I welcome your questions and comments.
Marc Becker, AIF
Managing Partner, Wiser Financial Coaching, LLC
*Paraphrased from “The Unbeatable Market”
** The “Wiser” way refers to a passive index approach to investing and is not an offer, solicitation, or recommendation of any specific investment or reference to any previous specific recommendation of Wiser Financial Coaching, LLC. Had an investor been following a passive index approach, the companies named would have been owned along with many other companies of the same asset class during the times represented.
This is not a solicitation or recommendation to purchase or sell any investment product or service, and should not be relied upon as such. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. The use of asset allocation or diversification does not guarantee returns or insulate you from potential losses. You cannot directly invest in an index. The views and strategies described may not be suitable for all investors.
