This last week was an excellent reminder that great companies, with stocks that have appreciated significantly, can turn on a dime.
Thursday evening (02/04/16) Linkedin reported strong earnings, beating the analyst estimates. Beating analyst estimates usually is a catalyst for higher prices, but in this case it was what management said about the future that moved the stock. And move it did. Linkedin lost over 40% of its value the next day.
What if you were an investor who purchased Linkedin on February 4, 2016? There were actually quite a few people buying Linkedin the day before it lost 40%, as volume on the stock was 4.8 million shares. Those investors lost over 40% of their money in less than 24 hours. They now must achieve a return of more than 65% just to break even.
Investing Should Be Boring
One of the hardest parts about real investing is that it is often boring, especially if you are diversified. Over the past few years many investors of diversified portfolios have become discouraged. If a portfolio were diversified among bonds, international stocks and US stocks, it likely appreciated “only” in the single digits. It significantly underperformed a pure US stock index, and didn’t come close to the returns of high growth individual stocks, such as Linkedin. Many investors have been tempted to abandon their diversified portfolios in favor of those stocks that had better returns.
It can be fun and exciting to own stocks that move and make a lot of money, but fun and excitement should not be synonymous with investing. That is speculating. Investing should be based on your goals – and I seriously doubt your goal is to beat some index or have a good time. Investing is about structuring a portfolio that will help you reach your goals, and sticking with that strategy.
Portfolio analysis tools take into account market sell-offs, recessions and other common occurrences. That is already built into the assumptions. A target return of 6% per year does not mean it will go up 6% per year. It means some years it may return 22% and other years it may lose 15%. We need to remember that.
Diversification is the Fruit of Uncertainty
We diversify across many asset classes because we do not know what will happen. It is not required that we “get it right” because we have spread our risk and over time we will reach our goals, so long as we adhere to our strategy. An individual that is not diversified has to be correct. Any error in judgment or company “surprise” can be very costly.
Of course being diversified is not as fun when markets are moving up. But having fun should not be an investment goal. Education, retirement and financial independence are goals. If you feel the itching to go more aggressive and be part of the action, you may want to ask yourself whether your financial goal is to have fun, get rich quickly or to progress toward your long-term goal. Save the fun for Vegas and allow the boring to help you achieve your financial goals.