The Risk of Individual Stocks

There are two rather enlightening posts on the Bogleheads forum today. Both dealt with the risk of holding individual stocks but from different angles: one from the employee viewpoint, the other from the “mad” or “fun” money viewpoint.

(1) The danger of holding company stock – by Taylor Larimore

Last year investment bank Bear Stearns stock was valued at $170/share. I doubt if anyone anticipated that today the stock would be worth only $2/share. How does this affect its 14,153 employees?

According to the Wall Street Journal, “The pain could be most acute for Bear Stearns’s (14,153) employees, who are steeped in a culture of personal ownership, and hold about a third of the firm’s shares outstanding.”

Bogleheads often warn newbies about the danger of overloading their portfolios with company stock. What’s happened at Bear Stearns is a good example.

(2) Managing your “Gambling” Money Allocation – a reply by hollowcave2

I am going to come clean today just to cleanse my soul and perhaps someone else can learn from my experience.

I had a 5% allocation in a mad money account that had 5 individual stock holdings. Not a big amount of money to each holding, 1 to 2% each. I was doing pretty good. I was beating the market in this small account and getting some good gains. I was getting pretty confident. I wondered why I had 95% in my fund holdings.

Well, unfortunately, Bear Stearns was one of the holdings. I really hate to post this, but I guess I just need some therapy. I thought it offered a compelling buy last week when it traded around $50. So I actually got 100 shares.

Well, you know what happened. This evens out my gains from the rest of the year.

I have a very high risk tolerance, but this experience really rocks my emotions. It makes me rethink my entire investing life. I never experienced such a loss in a matter of 2 days. It is definitely the worst investing mistake of my life.

So I hope to learn from the experience, and one of the things to learn is single stock risk. I”ve always known the risk, in theory. But to really experience it is something else. Life is a good teacher.

Both posts carry a great lesson for all investors — the risk of individual stocks should be avoided whenever possible.

3 Comments

  1. Nicky

    With that being said, how much do you plan on putting in Visa tomorrow?
    I think I’m going to take a risk for a change and buy 25-30k worth.
    Whats the worse that can happen?it goes down a bit, I’m thinking more long term, 1-3 years.

    Reply
  2. indexfundfan (Post author)

    Nicky, I was vaguely aware of the Visa IPO. I have no plans for it.

    Reply
  3. Black Hammer

    I’ve recently been back into stocks again after rolling over my 401k into an IRA. I suffer from the delusion that I can beat the index. I recognize it’s very difficult, but I’m going to try, with the help from Motley Fool. It is a subscription service for their premier newsletters, so essentially I am still paying a ‘load fee’ for my portfolio management. It’ll be interesting to see how I can calculate the year subscription fee into my portfolio returns.

    Reply

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