Oddly coincidental is the fact that in the last few private conversations I have had with friends and family, the topic of single stocks has been on the menu. So I found it fitting to address my stance on this with all of you. There’s a barrage of presuppositions about single stocks when it comes to our investing portfolios, but the biggest that stands out to me and which I will address is: single stocks provide better returns.
This in fact is a myth.
The truth is that single stocks bring on a considerable amount of risk. Enough risk that returns are diminished over a lifetime of investing. Yes, you can make a lifetime fortune getting in on an IPO of the next Google or Microsoft. But you will burn through hundreds of thousands of companies and dollars (millions for companies gambling on single stocks), and even then a monkey could tell you that there are no guarantees “the next great thing” will pan out.
Even if you aren’t swinging for the fences and are fishing for a return that beats inflation and taxes, single stocks are still too risky and faulty. In principal, say you invest in a stable, strong and huge mega-company that represents a backbone of America, like say McDonald’s. A few decades worth of stable and (I’ll give you the benefit of the doubt) great returns of say over 12% during the life of the investment, can all be undone by a corporate scandal, E.coli outbreak, worker strike or bankruptcy filing (these things can NEVER happen, right??!!). And these events can and will leave a single company reeling for years, diminishing your previously earned returns. As quick as that stock price can rise, the quicker it can fall.
But let’s look at a real world example. Let’s pit a traditional, American company, Bank of America (BAC) up against one of the finer mutual funds I know of, Aston/Fairpointe Mid Cap (CHTTX). We’ll use the crash and boom of 2008 and 2011 as our backdrop. Say you invest $1,000 on January 7th, 2008 in each of these investment options. For BAC, this would have bought you 25.97 shares of BofA at a price of $38.50 per share. For CHTTX, you would have 37.75 shares at a price of $26.49 per share. At its absolute worst, the mid-cap mutual fund’s price fell to $13.29 per share during the week of February 23rd, 2009, halving your initial $1,000 investment to around $500, pretty rough huh? Well you ain’t seen nothing yet! During that same week, BofA shares fell to $3.95 price per share, plotting your initial investment of 1K down to roughly $102. As of today, BofA stock is bouncing around 6.66 (interesting huh?!) and after about 4 years, your 1K is now worth $172. As for the example where we held CHTTX, at the previous trading day’s close the price was $30.96 per share, meaning your 1K investment is now worth $1,168.
Now I’ll be nice, over a human lifetime the BofA stock will come back. Once the geniuses that run that company figure out that giving loans to people who can’t pay them is a recipe for disaster, the company stock will recover. While we wait for that to happen, for long term investing I’m going to park my money with a proven, time tested mutual fund that has been around for at least 10 years and has average annualized returns of over 10% since inception. You see, GOOD mutual fund teams live, breathe and eat company evaluations. They look for long-term growth potential and low debt to income ratios. I do not have this much time, schooling, nor team members around me to even come close to this expertise. Neither do you. You and your golfing buddy do not have this figured out. In short, single stocks leave you vulnerable to down-markets/company scandal/stupid decisions, and investing in a GOOD mutual fund for the long term is one of the pillars to financial peace.