We’ve all been there – you are at a party, or with a group of friends, and someone is telling you how they just bought 100 shares of Amazon, or $500 worth of Bitcoin. “The investment is already up 20%. You should get in on it before it goes higher!” These stories are all too common. But how many stories have you heard where a friend made a similar purchase, and the investment was down 20%? Funny, those stories aren’t shared very often.
If you bought 10 shares of Facebook on February 3, 2022 for roughly $323 per share, your $3,200 investment would have been worth less than $2,400, or down 26%, by the end of the next day. This was due to the company reporting lower-than-expected earnings and a shrinking user base, which caught most investors – and even investment professionals – off guard. However, investing the same amount in a diversified portfolio like the S&P 500 index would have shown a modest increase. Diversification may not prevent losses entirely, but it can help mitigate extreme losses like a 26% drop in a single day.
Other single stock cautionary tales:
- First Republic Bank – With the collapse of Silicon Valley Bank in early 2023, depositors, investors, and other banking institutions became fearful of additional bank failures. But why should investors worry about First Republic, one of the most well-respected and apparently sound banks in the country? In a matter of months, investor fear, combined with a great deal of deposit withdrawals, made an investment in First Republic worthless. Even some of the smartest investment professionals were investing in First Republic days before J.P. Morgan purchased the company and wiped-out equity holders.
- Peloton Interactive – Before the pandemic, Peloton was a reputable gym and at-home workout solution. During the pandemic, it became one of the top solutions for at-home fitness as gyms were closed and everyone could not leave their homes. The stock soared from $29 per share at the beginning of 2020, peaking at $167 a year later as Peloton stores began popping up in malls and Peloton trainers reached celebrity status. The company’s pandemic-driven success did not last and the stock trades at roughly $7 per share today, down 96% from its highs.
These cautionary tales offer up several key takeaways:
- Diversification reduces risk by spreading investments across various asset classes, and is more effective than relying on a single stock or asset class. For example, strong performance by U.S. companies over the past several years has led some investors to question the need to own stock in international companies. However, international stocks have outperformed U.S. stocks thus far in 2023.
- Timing the market is unpredictable and emotions often lead to poor investment decisions.
- Investing in individual stocks is okay if you understand the risks and can afford to lose your investment. Taking financial risks earlier in life is easier as you have longer to recoup any losses.
- Professional fund managers have the time and resources to make informed investment decisions on multiple stocks. A fund manager used by HTG stated that it takes their portfolio managers, on average, 40 hours a week to stay apprised of the data and research to make informed decisions on just one company. Do you have this kind of time to dedicate to one investment? What if you owned a dozen stocks?
Take Action Now!
- Review your investment portfolio and assess if you own a range of asset classes, market capitalizations, and industries. Proper diversification will significantly reduce your risk profile and can be most efficiently obtained by investing in mutual funds or ETFs.
- Consider your investment time horizon and allocate investments with the appropriate level of risk, balancing cash and short-term investments with riskier investments to achieve long-term goals. This helps avoid being forced to sell in a down market and missing out on gains.