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Ardent Listener
Administrator
USA
4841 Posts |
 Posted - 08/08/2008 : 19:44:08
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The Best Way to Lose Everything
by Alexander Green, Chairman, Investment U
Investment Director, The Oxford Club
Dear Investment U Reader,
Back when I was still managing money 10 years ago, I had a client who transferred in a rather sizable account.
There was only one problem. Over 90% of his net worth was tied up in a single stock, Ericsson. He refused to use a trailing stop or sell a share of it.
I warned him it was crazy to have his entire financial future riding on one
stock, especially since he was retired.
"That's what everybody keeps telling me," he said. "But the stock keeps going
up. I'm glad I ignored them all."
I congratulated him that the stock had appreciated so nicely. But I reminded him there might come a time when it didn't do so well.
He said he couldn't afford to pay the capital gains taxes.
I reminded him that long-term capital gains are taxed at a maximum rate of 15%.
But he was stubborn. He wouldn't part with a share. Furthermore, he grew weary of having the same conversation. He transferred his account out again.
You may already know how this story ends. From a high of over $105 in March 2000, Ericsson took a breathtaking dive. It traded at less than $5 two years later.
This is the kind of mistake - especially when you're already retired - from which recovery is simply not possible.
However, I sometimes see other investors making similar mistakes. Every so often a reader will come up to me at an investment conference and proudly announce, for example, that he has his entire IRA invested in one of my stock recommendations.
This is meant as a compliment, I realize. He wants to show me he has confidence in my stock selections.
But it makes me cringe inside.
Just as the Ericsson shareholder failed to diversify properly, so do many investors who fail to follow our basic position-sizing strategy.
You shouldn't put more than 4% of your equity portfolio in any single stock. (At least initially, anyway. It may grow to be a much larger percentage. But that's fine as long as you protect your profits with a trailing stop.)
Here's why you should follow this advice, especially if you consider yourself risk averse.
Our policy is never to let a stock fall more than 25% below our purchase price without selling it.
If you take the maximum loss (25%) on your maximum position size (4%), it means the value of your stock portfolio has fallen just 1%. And if you have no more than 60% of your portfolio in equities, as we currently recommend, the maximum potential harm done by a single stock cratering is this: Your total portfolio is worth six-tenths of a percent less.
Most grandmas could live with that.
Everything we do - asset allocation, trailing stops, position-sizing and stock selection - is done with an eye to not only maximizing returns but also limiting risk.
It's fine if an individual stock grows to become a significant percentage of your total portfolio, provided you are running a sell stop behind it to protect your profits.
But don't let your confidence in any stock - or any stock picker - allow you to abandon basic money management principles.
As Thomas Jefferson once remarked, "In matters of style, swim with the current. In matters of principle, stand like a rock."
Good Investing,
Alex
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Think positive. |
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Steiner
Penny Collector Member
Canada
278 Posts |
Posted - 08/08/2008 : 21:10:41
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I really feel sorry for the old guy. In his defense, stock brokers love to have you to move around and make lots of trades. It makes them money! They will tell you they are just taking care of you and they are in a way but they are also taking care of the firm.
I agree with diversifying but I still my best money makers are working, my real estate(read house), and PM's.
If the housing market continues to crash wouldn't it be nice to pay for an undervalued house in copper, nickel, silver and gold?
Usually if PM's are going up housing is going down.
Steiner |
Steiner |
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CoinHunter53562
1000+ Penny Miser Member
USA
1805 Posts |
Posted - 08/08/2008 : 22:11:16
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What is your advice regarding assets as far as the recommended mix of cash, 401K, PM's, stocks, etc?
I'm heavy into PM's, compared to my cash position and I wonder every day if I should move some back. But then I keep hearing how the dollar is going to crash and silver will go up nicely so I sit and do nothing. For example today silver is at $15.29 so should I take a little cash and buy some PM's or sit tight? I know no one knows the 100% correct answer but just curious as to how people like to sit between cash, PM's, etc. |
My hobby: collecting real money 1 copper cent or nickel at a time.
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Steiner
Penny Collector Member
Canada
278 Posts |
Posted - 08/09/2008 : 02:43:22
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If I were you I would be buying silver, but I am not you. The price IMO is very good right now. Gold also.
Steiner |
Steiner |
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pencilvanian
1000+ Penny Miser Member
USA
2209 Posts |
Posted - 08/09/2008 : 09:17:51
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I think one of the morals of this story is one I have mentioned previously-
Your Exit strategy is as important (if not more so) than your entrance strategy.
There is no shame in taking money off the table instead of letting it all ride. Smart and successful gamblers and investors know that a bet or investment has more chance of losing when the stakes get higher or when the price goes up for a long time.
Betting all on one stock is much like betting ten grand on red at the Roulette wheel, yes you could win but you could just as easily lose it all, and considering Murphy's law, you will lose (anything that can go wrong, will, and at the worse possible moment.)
Lastly, fight the feeling of greed as prices rise.
Bulls make money
Bears make money
Greedy pigs get slaughtered.
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Nickelless
Administrator
USA
5580 Posts |
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The Best Way to Lose Everything.
Forum Locked
Posted - 08/12/2008 : 06:01:25
