You may think of someone who only owns thousands of shares in Apple as a genius and untouchable for when the market turns sour but it turns out they are in a very risky situation. Sure things may look great now and may even look better ten years from now, but at any given point between when you own them and sell them anything can happen and you can lose it all!
We are not simply talking about diversification here, although that is one principle. Instead, the hope is to degrade the notion that if you only have one stock or you have a handful of stocks that are home runners you don’t need anything else. However the inevitable happens and stocks do fall to disgraceful levels at no fault to the company or the price you paid.
Famous Examples of ‘Great Stocks’ People Have Had Too much Money In
Aside from the Market Crash of 1929, the Great Recession of 2007-2008 and the .com bubble, many individual stocks have fallen to deathly levels that were once home run hitters, darlings within stock analyst circles.
Enron (ENE) – Enron was an incredibly profitable company, one that was not part of the hot telecom and tech industry but the tried and true energy sector. When Enron was voted the most innovative and exciting company by Fortune for six straight years, no one had any clue that the company was head first in accounting fraud.
All of the employees of Enron had no idea that there company’s stock was “too much of a good thing.” Many were feeding off the media’s perception as one of the most innovative and powerful company’s in the world. To many of them, there was nowhere to go but up. Many invested not only their income but life savings.
Facebook (FB) – Of course we all know about the botched IPO that turned a $33 stock into one that is currently less than $20. Employees were quick to liquidate, however many have at a substantial loss to the initial valuation. This is not a problem if you did not invest money in the equity as an employee, however it is a lesson in perceptions, which plays an important role in having too much of a great stock.
We can debate whether or not FB was a great stock or whether or not it will be. The important point is any investor who held shares or wanted to purchase shares had an idea of the next Apple in mind. Making plans with currently high or great stocks is also dangerous.
Crazy Eddie (CRZY) – The Antar family famously took this retail tri-state success to their personal bank account. Initially skimming almost $1 from each $5 made the family scaled back at the time of the IPO to give the perception that the company was actually more profitable than it was. Analysts were excited and investors wanted a piece of the growth. The company fell apart completely in 1989.
The board members tried to save the company after outing the Antar family but their accounting fraud and funneling of money to Israel was so deeply entrenched the company was salvageable. The rule of thumb here is that we cannot see everything in a company or its stock, not even analysts.
Sometimes even key board members are out of the loop such as in the CRZY case. Thus we have to hold even the highest paying and most rewarding stocks with a grain of salt and skepticism.
Mistakes we Can Avoid From Having too Much of a Great Stock –
Don’t Invest with Emotion – Investing with emotion can be incredibly dangerous At that point investors tend to disregard solid metrics for judging the fundamentals of a company and begin to trust instinct, gut or worse what the public says.
Cash Out – Many times we get so deeply involved in a company’s losses that we cannot handle the thought of cashing out and taking a loss. It sounds counter intuitive but if the evidence comes forward that everything is going down, wouldn’t it be better to have some of your money rather than none of it?
Don’t Just Trust the Fundamentals – At a company like Enron the fundamentals looked perfect for years, even though they were fake. No one would have known until an investigation brought it forward. The normal investor does not have the time to test these metrics or judge their validity.
Always Remain a Skeptic – My favorite strategy is to never treat a stock as your best friend, even if it has become one to your bank account. For every great thing you find out about a company find two more that are awful. You’d be surprised how many potential investments you no longer see potential in. This strategy helps hone your selection skills.
Anything could Happen at Any Time – Truth be told it could be as simple as a labor strike or dramatic as an environmental disaster. Any political, social or economic situation could turn your darling of an investment into junk within minutes.
What we Should Do Instead – Try to Diversify
It’s awfully difficult to many investors to be properly diversified to avoid the majority of conflicts and wrecks that could come to their investments. Nevertheless there are a few strategies to take to ensure that you stand a better chance of surviving the unexpected.
Try ETFs – ETFs are one of the simpliest ways to avoid a lot of risk in investing. If you are wise enough to stick to the broad based index funds and general market metrics you stand less of a chance at losing big when a certain big stock drops. It will be only a very small percentage of that ETF.
Work Towards Diversification – You don’t necessarily have to be completely diversified and hold 30 different stocks but make a plan and honest effort to get there. If you can only afford to hold 6-8 different securities spread out your risk and accumulate holdings in each of them instead of all at one time.
For example instead of buying all of the shares you want in Apple now, buy a quarter now and work on a different stock next. This will help spread out your risk. You will also accomplish this buy introducing yourself to a position instead of buying everything you want in it.