Last week I explained how Average True Range could help investors decide how many shares of a given company to buy. The post that immediately followed mine was Scott Raynovich's report on expected volatility in the market this summer. Even though portfolio composition was coincidental to broader topics, the post evoked a spirited discussion about position size.
It's fair to say that Scott and I looked at the issue from different perspectives. My approach was purely arithmetical. Scott's was more intuitive. So which one of us is right?
The honest answer is: We're both correct. Position size depends on the goals and methods of the investor, so there's no one-size-fits-all answer.
For some, taking a big stake in a single stock is fine. This is especially true for an investor who works for a company where he receives stock dividends, or who has a comprehensive view of the company's potential. For others a balanced portfolio is best. It works well for investors who are driven by fundamentals, have studied a range of companies, and found several they're willing to hold for as long as it takes each one to reach its potential.
Having said that, I still believe there is room for those who chose to divide their investments among several stocks based on their relative volatility. Unless you believe one investment will gain more than another, how can you justify accepting greater daily or weekly variability from one stock over the other? Why would you knowingly accept more risk from one investment than from another if your expectations for them were equal or unknown?
In addition, I see no justification for holding a group of investments that vary by more than you are willing and able to lose. Unless you are clairvoyant, you have to accept that bad luck or poor judgment can ruin a promising company and destroy a portfolio. A loss of 20% requires a gain of 25% to replace, and the S&P 500 has gained just 3.2% in the past 10 years!
Tomorrow: How will a 20% loss affect someone who is planning to retire in 2021?
— Fred Goodman, a registered investment advisor and Certified Financial Planner, publishes MarketMonograph, a daily, Web-based subscription service specializing in technical stock market analysis and the application of economic indicators to market timing. You can reach him at fred@marketmonograph.com.
I agree that you need to be careful when you hold stock in the company you work for and that you do not get too emotional about that. I think it is a good idea to make sure your financial advisor knows how much stock or options you have in the company you work for and helps with how much you should keep or sell. That should take some emotion out of those decisions.
Great point. Employee shall emotionally detach from his feelings while they make any investment decisions. Lots of other examples, such as Nortel. A company has a wonderful 100 years history. Well, lots of employees didn't make exit decision in time. I also make a similar mistake once. Hopefully we don't do that again.
You are right, Value Hiker. Thank you for pointing out this. The employee moral and working environment are two important factors. Learned something and getting a little better every day, hehehe...
Its very easy for employees to get emotionally attached to stock options and stock purchase incentives viewing them differently than their other investments. It is critical for an employee to understand that these are just like any other investment and they should make their decisions based on the fundamentals of risk and diversification. Remember Enron employees and their blind faith in the company?
There are two kinds of information that employee can have.
Some are short term like current quarter earning, merge or buyout. If employee made trade on these non public information, they are inside trader. But these kind of information are rarely available to regular
employee unless you are at VP or above level.
Other information are more helpful to long term investor, like industry trend, competition pressure, employee morale, management talence etc, which are usually public available information, but unless you work for the company, it is hard to detect it in detail. That is the information that Philip Fisher recommends long term investor to check. Any careful employee can detect these information far earlier than wall street
experts. That is the edge I talked about and it has nothing to do with inside trading.
Well, that sounds like an inside trader, not a normal employee. A normal employee doesn't always have previligy to get all info. They still need to do their own research. I am not mouth for financial advisors, I don't think they know any better. But anyone shall do their own research for the investment.
Exactly, unless you are clairvoyant, don't venture into territory that you normally wouldn't. Investors should not let greed take over, and end up paying the price at the end.
It all depends on which company you work for. If you worked for Cisco at early 1990s, or Google at early 2000s, do you really want to sell your cisco or google stock to diversify into 3com or Yahoo? On the contrary, if you work for 3Com or Yahoo at the same time frame, you know your company is beat down by Cisco and Google, you shall sell your shares and diversify into Cisco or Google, at least to SPY.
Most of time, LONG TIME employees know their company well, and can predict the company's success or failure much better than Wall Street Analysts. Why shall these employee listen to the financial advisor who know barely nothing about their company ?
If you are new to the company, or the kind of employee who know nothing about his company's business environment, major competitors, new product in developing, etc, then you don't have any edge over your financial advisor, please listen to financial advisor's opinion, go diversify.
An investor who works for a company where he receives stock dividends needs to be especially careful about more than just diversification. Timing is a real factor to consider, too, because he or she may be restricted as to when options can be exercised, when stock can be sold, etc.
There is also the concern about not so much literal inside information but company loyalty affecting one's investment judgment. Overall, it's tough to apply the same standards of objectivity to such an investment, and that makes having good counsel and overall diversification of portfolio risk all the more important.
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Voters feel more favorable about an incumbent president when the economy is good. So expect the Obama administration to do everything possible to push up the market.
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