Investing in single stocks can pay off big (early Apple), result in disaster (Enron), be a long-slow decline (GE), or be a roller coaster (most companies over time).
There’s a strong allure to picking stocks. It’s part of the American dream to win big and reap the rewards from taking risk. But individual stocks are risky in many ways:
Market Risk: This includes changes in market conditions, such as interest rates, foreign exchange rates, and stock market fluctuations.
Credit Risk: This is the risk of loss due to a debtor’s non-payment of a loan or other line of credit.
Liquidity Risk: This refers to the risk that an investment may not be easily sold or converted into cash without a substantial loss in value.
Operational Risk: This encompasses risks arising from the company’s day-to-day operations. It can include everything from internal processes, systems, and people to external events that impact the company’s ability to operate.
Compliance and Regulatory Risk: This involves risks associated with the need to comply with laws and regulations.
Strategic Risk: This is related to the management’s decisions regarding the strategic direction of the company. Poor strategic choices can lead to a loss of competitive advantage or market share.
Reputational Risk: This is the risk of damage to a firm’s reputation, which can result in loss of customers or decreased revenue.
Geopolitical and Country Risk: This involves risks associated with political changes or instability in a country, which can affect investments in that region.
Environmental, Social, and Governance (ESG) Risks: These risks are associated with environmental, social, and corporate governance factors that can affect a company’s performance and valuation.
Technological Risk: This relates to risks arising from new technology that can render a company’s products or services obsolete.
The ability to continuously monitor and evaluate not only the risks but strengths, opportunities and weaknesses of a single company is the full time job of teams of investment managers. It’s a herculean task for individual investors to perform the same due diligence.
It’s been said that the returns from single company stocks are an “uncompensated risk” because the risk cannot be reduced or eliminated by diversifying. While there could be outsized returns, there could also be also ruin without a backstop.
A common technique for those that want it both ways: diversification for the long game and the potential returns from picking winners is twofold:
Keep the single stock portion of a portfolio to less than 10% of the overall portfolio. Be willing to lose it all.
Ensure that after sound analysis, complete loss of the single stock portion doesn’t prohibit retirement goals.
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“Winged Wealth Management and Financial Planning LLC (“WWMFP”) is a registered investment advisor offering advisory services in the States of Florida and Texas and in other jurisdictions where exempted. Registration does not imply a certain level of skill or training. The presence of this website on the Internet shall not be directly or indirectly interpreted as a solicitation of investment advisory services to persons of another jurisdiction unless otherwise permitted by statute. Follow-up or individualized responses to consumers in a particular state by WWMFP in the rendering of personalized investment advice for compensation shall not be made without our first complying with jurisdiction requirements or pursuant an applicable state exemption. All written content on this site is for information purposes only. Opinions expressed herein are solely those of WWMFP, unless otherwise specifically cited. Material presented is believed to be from reliable sources and no representations are made by our firm as to other parties’ informational accuracy or completeness. All information or ideas provided should be discussed in detail with an advisor, accountant or legal counsel prior to implementation.