Over the years, I’ve talked with many young people about their desire to invest. Almost to a person, they are interested in investing because there is a popular, new product or service that excites them. This excitement helps them want to invest in that company, even if they are neophytes to the investment world. This does not bother me, as I love seeing people be motivated to become active in our economic system. The issue arises, however, that what is a cool product may be an investment that is about to mature in its attractiveness.
My friend’s son has me manage some investments for him. When we began our relationship, he wanted to talk about investing in Tesla motors. This was in the fall of 2014 and Tesla (TSLA) was selling in the neighborhood of $240 per share. Yes, in four years TSLA had become a ten-bagger, having risen to $241 from an October 2010 price of $21. To him, this looked like a great investment and, it would be, if that rate of appreciation had continued. Instead, in the fall of 2015, TSLA was selling for $207 (a loss of 13.7%) and the good news is that, today, it is selling for $262 per share (a gain of 8.7% from the 2014 price). One does not know if the “investor” would have still been in the stock or would “the emotional trader” have sold when the price was low.
Have you ever eaten at a Chipotle (CMG)? They do have good food and, in the fall of 2014, their stock was selling at price of $638, having risen from a first month’s (January 2007) price of $45.60, or 1,299%!! Of course, we all want on that bandwagon but, had you purchased CMG in the fall of 2014 with the hopes of winning the race, you would now own shares worth 28.2% less than at purchase. You did not imagine that there would be an e coli outbreak at the fast-food chain. As a result, it looks like you’re a little behind in the race – not winning.
Similar stories can be told about other stocks and, of course, there are real success stories where fortunes are made on the current, coolest thing to hit the market in years. Yet, for a beginning investor, looking for a way to invest in the market, I always recommend a couple of things. One, I ask, “How long are you able to invest the money without needing the principal?” Before you invest in the stock market, this time period should be no shorter than five years and, preferably, longer. In the above examples, had you gambled your house-down payment-to-be on either of these single stocks, instead of the return you had hoped to receive you may receive less and, perhaps, lost some of your down payment if a house purchase is relatively soon. If the beginning investor believes that they can invest for over five years and they want to get started, I recommend that they consider an index mutual fund or exchange traded fund. What would have happened to this investment over the eighteen months from October 2014 to today?
In October of 2014, the Standard & Poor’s 500 Index ETF (SPY) was selling for $195.49 per share. Currently SPY is selling for $204.19 and sports a 2.1% dividend yield. This is approximately an annual yield of 4.96%, although in January of this year SPY had a price a little less than $193 per share for a 1.4% loss to be recouped by April. Moreover, this return came with a lot less volatility than in either of the “cool” stocks above. Why? Diversification.
Purchasing a single investment is risky. Being risky, you may make a lot of money, if it turns out to be a great company. Being risky, you may lose everything, if it is a poor investment. You do not know. On the other hand, by investing in an index mutual fund with a focus on the United States, you will have purchased a little of every company in the index and will have taken a position that represents the largest companies in the United States. This reduction in risks, lowers your expected return, while reducing your risk. Moreover, an investment in The Market of the United States, provides you with an investment for the long-run. (You will not have to worry about little things like food poisoning getting in your way.)
Never forget that financial success follows from your discipline to save money over a long period of time in a diversified portfolio. If you do this, while not as exciting as watching a rabbit zig-zag across the yard, you will be successful. For, just as the fable of the turtle and hare attests, slow and steady will win the race. Swinging for a home run with your investments may seem attractive. It is, however how most batters strike out.