Single Stocks: Can You Handle The Risk?

When I meet a new acquaintance for the first time, more often than not, they want to tell me about the stocks they own.  Apple and Tesla come up rather frequently, among other companies.  They always seem somewhat disappointed when I tell them that I do not use single stocks in any portfolio that I manage.  When I invest, I own a basket of stocks that represents an “asset class”, such as the S&P 500 index or Russell 2000 index for example.  Owning single company stocks makes for great cocktail party conversation, but I think very few people understand the risk they are taking with owning a concentrated stock portfolio.  Here are two key points everyone should understand before purchasing single company stocks:

Single Stocks Can Have HUGE Drawdowns

A “drawdown” is a trading term that refers to the distance any security is from its high in a given time frame.  Most people look only at the gains realized by an Apple or Amazon over the last decade – they do not look at the “pain” they would have had to endure to achieve those gains.  This article does a fantastic job of showing the drawdowns in Amazon’s stock since 1997.  The article states that to achieve the 38,000% gain in Amazon stock since 1997 you would have had to endure a 36% average drawdown at some point in the year, EVERY YEAR!  The largest drawdowns were 83% in 2000 and 64% in 2008.  Very few people can handle losses that big and they would sell out of their position before realizing the large gains.  By owning a larger basket of stocks, you forego the large potential returns of a particular single stock but you can also significantly decrease the volatility in your portfolio so that you can hold on through the tough times.

Only A Handful of Stocks Are Responsible For Market Gains Each Year

In any given year there is a huge dispersion of returns for stocks in any index.  If you “miss out” on the best performing stocks then you will significantly trail the index returns.  This article from Bloomberg shows us that if you did not own the ten best performing S&P 500 stocks in any year (1994-2014), then your returns were almost half of what S&P 500 returned.  Said another way, 2% of the companies in the S&P 500 were responsible for about 50% of the index return.  How good of a stock picker are you?  Can you pick the top ten S&P 500 companies this year?  And next year?  And the next?  Owning ALL 500 stocks in the S&P 500 ensures that you will own the top ten performers year in and year out.

I am not trying to discourage anyone from using single stocks in their portfolios – I just think few people understand the risks.  Active mutual fund managers are paid to pick the best stocks – you can read this article to decide for yourself how well they have done.  If you want to swing for the fences, just understand that you may strike out.  Most people can’t afford to strike out when it comes to investing for retirement – sometimes hitting singles each year is all that’s needed to reach your retirement goals.

Charles Brown is a Portfolio Manager and Financial Advisor at M.Brown and Associates in Naperville, Illinois.

***The above article is informational in nature only and is not a recommendation to buy or sell securities.  All information is gathered from sources believed to be reliable, but neither Charles Brown nor Ausdal Financial Partners, Inc guarantees the accuracy of the information.  All investments carry a degree of risk.  Individuals should consult with their tax and investment professionals before making changes to their investment portfolios.