Are All Your Investment Eggs In One Basket? Maybe So - Without You Even Knowing.
Are all your investment eggs in one basket? Can a good company be a bad investment? Check out this video as I discuss the dangers of putting too much of your portfolio into one company's stock.
Patrick: Are all your eggs in one basket? They just might be without you realizing. Find out more coming up.
Hey, folks, I'm Patrick King with Transformative Financial. Here on this channel we help people make money, keep money and feel more financially secure along the way. If that sounds like something that you would be interested in, I would love to talk with you to see if it's a good fit. My email is firstname.lastname@example.org. My phone number is 404-500-9261. On today's episode, do you have your eggs in one basket without even realizing?
When I looked into the origins of that phrase, "Don't put all your eggs in one basket", it's something that we all intuitively know. We don't really know what the origins were. It goes back even to the 17th century. Some people credit Cervantes and Don Quixote with the origin of that. I came across an old German phrase that I liked even more. It goes something like, "Make sure that you have enough legs to stand on". When it comes to your investments, I think that's probably an even better phrase to use, in the way that I think about how to structure investments and reduce the risk of your investments, your total portfolio.
When you think about putting all your eggs in one basket, if you've been around investing at all, you know that this is something about diversification. It’s really the only free launch in investing. Instead of putting all your money into one stock, you certainly want to spread it out to take the risk away from whatever happens to that one company. If you think about companies out there that are on the stock market, everybody has to deal with economic and market risk, right? Every company out there.
Each company has a specific risk or risks that they have to deal with on a day-to-day basis that may make their stock do something different, positive or negative, than the market in general, right? What you want to do is, obviously, by investing in a basket of companies, reduce the risk associated with what can go wrong with one particular stock. This is something that's very intuitive and we all know this just intuitively. So what drives folks, and there a lot of us out there and I've certainly done it in the past before I became an advisor, where we invest in one stock?
Why would you want to do that? It's a temptation, right? Because all of the information, well maybe not all, but a large majority of the information about these companies is out there, it's publicly available. Thanks to the internet we can find out just about anything about publicly traded companies in real time.
Number two, I think this is maybe more of a reason, is that we have familiarity with a lot of these companies. We want to say, hey I use their products every day, I'm a big fan, I'm a big believer, so I want to make an investment in that company.
That brings me to the final point, which is often folks confuse a good company or a good product with a good investment. They're not necessarily the same thing in a lot of cases. Today, things that are coming up when I talk to folks a lot recently, an example would be Tesla. Tesla, especially with my engineering background, I'm very impressed with the Model S and the electric car. You've got 100% of the torque 100% of the time and fewer moving parts.
I think eventually once the battery densities start to come up you'll see more and more successful electric cars out there. The question about the investment side of Tesla is a completely different question, right? Right now they're struggling with some operations issues, getting the Model 3 out on time, they've got a lot of promise, they've got potentially some quality issues that they have to deal with, then they've got some investor issues too. They're trying to raise more debt financing for the company.
Great product, perhaps not the greatest investment at this point. Whether they survive or not is yet to be seen. I'm not saying don't have any investment in Tesla, but you certainly don't want to go all in right now.
Then the flip side of that would be a company like Amazon. Amazon's doing really well right now. Unfortunately, they're dealing with other problems like the President tweeting and their share price going down on the same day, obviously referring to President Trump's tweets about Amazon. As an investor, yes, it's a very appealing company right now, there are also issues out there that may be beyond the company’s control, beyond the investor’s control that could potentially lower the value.
Just to put this issue in perspective, years gone by, you look at the good product versus good investment. I think back, I banked at Wachovia, investing in Wachovia would have been a bad idea. I loved Circuit City when they still existed, bad investment idea. I owned a Nokia telephone, I guess Nokia's still around, but they're not in the game like they were, right? Those are great examples of, just because you're a believer, just because it seems there's no reason these companies shouldn’t exist into perpetuity, that you should go all in with their stocks as an investment, as part of your portfolio.
Of course, there are times when you can’t get around having an individual stock in some significant fashion in your portfolio. Great examples of these would be folks who have an employer stock purchase program where you can buy your employer stock at a discount. Or if you're a C-level executive and you have a minimum share requirement of the company that you are working for. Then, of course, you're blocked out on certain dates where you can make transactions on that stock.
When you running into those issues, or you've got old stock with a ton of appreciation in it, you don’t want to sell it all and get a big capital gains tax bill, right? [laughs] We want to have a plan for that.
In those cases what I normally do is, I recommend we make a plan, we limit the exposure to that one particular company to less than 5% of your entire portfolio.
Once it gets about 5%, it's a concentrated position. That’s the time that we have for it. It's a abnormally large exposure to one company in your portfolio. So, 5% is the max where I start to get uncomfortable if it goes over that number in a client’s portfolio.
So the key takeaway here, every company has to deal with market risk and economic risk, but with diversification, you don’t have to take those risks.
You can take the market risk and economic risk and get paid for that over time, quarter by quarter it’s obviously going to vary. You don’t have to take the risks that are involved by investing in just one company or just three or four different companies.
That's what I got for today folks. If you want to learn more about diversification, there are plenty of resources out there. I'll post links in the show notes.
If you like this video, click “like”. Of course, subscribe if you want to have more of this kind of content. Again my name is Patrick King with Transformative Financial. Thank you for watching. Until next time, cheers.
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