Don’t Make Large Stock Bets

In heading down the right investing path, there is no room to make large bets in your stock portfolio.  Here is some background on the reasons investors make large bets, followed by the reasons for not making these stock bets.

Why investors make big bets.

First of all, there is a psychological effect at work when you make big bets.  Either you have done well on a stock and you feel vindicated that you were right.  You fall in love with your stock and feel that its prospects are so bright that it should be priced a lot higher.  You have been winning for so long that you feel invincible, as though you can’t be wrong, so you keep buying the same stock and making a big bet.

The other reason for making a big bet (and there are probably more than these two) is that you really like a stock and its price keeps falling, so you decide to double down, again and maybe a second or third time.  Nothing has changed for the company except its stock price, so in effect you can buy it at lower and lower prices.

Why big bets don’t pay off.

The problem with making big bets is that you will be wrong.  Maybe not everytime, but you will be wrong most of the time.  And when you’re wrong, you’ve just sacrificed the returns on your portfolio.

In the first scenario above, when you make a big bet on a stock because you have fallen in love with it, you are not using an objective view point and are instead buying on sentiment.  If you love the stock this much there’s a good chance that the whole market does.  This creates a market darling.  And when a stock like this falters, even a little bit, the stock price will get devistated in a very short period of time.  No stock is popular forever, and when you are betting on a popular stock you will eventually pay the price of it falling out of favor, which is very steep and can last for years.

In the second scenario, where you are doubling down a stock because its price is falling for “no reason”, you will also lose most of the time.  The reality is as follows:  The stock is likely falling because something is fundamentally changing that will affect their long term growth.  Whether its slowly losing market share, pricing in a bad economy, or just in a bad industry at a bad time, something will likely happen that will justify the lower price.  Maybe an analyst will drop estimates, a CEO will resign, the company will miss earnings estimates.  You never know what news will be coming out, but chances are if your big bet stock keeps falling, its for good reason.  The second reason these types of stocks keep falling is because investors ride the momentum.  Like Newtons law, stating that an object in motion tends to stay in motion, falling stocks tend to keep falling.  The more they fall the more people will sell and continue the decline even further.

Our conclusion.

So, no matter how confident and involved you get with your investments, stay well-balanced and diversified. Don’t make large bets on any stock, sector, or other investment. Large bets can wipe out years of gains in your portfolio overnight. Trust us, we’ve all made the mistake of putting too much money into one investment. Especially when it keeps falling and you think its prospects are so bright. Almost every time we’ve done this, the stock came out with news that proved the low price right, and left us with a big void in our investment portfolio. Don’t make large bets. Stay diversified.

Stocks investing, stock bets