Diners in Boston’s beloved North End are almost guaranteed a great meal. There are so many places to choose from and the competition between among restaurants them is fierce. If a chef doesn’t make mouth- watering entrees, customers can easily flock to the highly rated place next door. The customer can also stay in the suburbs and dine at places like Campanales in Braintree or Mezzo Mare in Hull. This sets the culinary bar astronomically high. While you can only choose one restaurant for a meal, the abundance of choice reduces the risk your palate will be disappointed.
When it comes to investing, though, choosing only one stock for all your money increases your risk of a disappointing return. In the financial markets, taking advantage of the diversity of choice and buying some of everything will increase your chances of winning. Let’s examine the additional risk you take when concentrating all your risk in one company. For this exercise, imagine all the places in the North End are publicly traded companies.
Good economic times bring more visits, and profits, to establishments like Giacomo’s Ristorante. If this is the only stock you’re holding the good times are sweet, but in broad economic downturn it could be difficult for the management to maintain a profit. During recessions, consumers eat out less but the management still has to pay the rent. Any decline in earnings would negatively impact the stock price. Alternatively, a disruptive technology could come along that renders the Chicken Piccatta expert obsolete. It is not out of the question that a brainiac at MIT could invent a technology that prepares chef quality meals at home. Investing in a variety of stocks spreads your risks among recession resistant companies and high growth potential start up’s.
The history of commerce is filled with poor business decisions. Many of us have been in meetings where everyone knows management is making a mistake, but no has the coraggio (courage) to say so. Imagine if the owners of Mike’s Pastry shifted focus to selling Kellogg’s Pop tarts. Holy Cannoli would there a stampede to Bova’s on Salem Street. Mike’s probably would alienate their customers for life. There goes the profits and the stock appreciation. This is far- fetched, but much bigger blunders have been made. Do you remember the people buying all sorts of public relations to convince Bostonians we wouldn’t pay a cent for the 2024 Olympics? We weren’t buying it. They would have had an easier time selling Totino’s frozen pizza outside of Galleria Umberto.
The drought in Boston this year is a strong reminder that Mama Nature is still in charge of the planet. Imagine this drought was extremely widespread and very prolonged. Those conditions would destroy the wheat crop sending pasta prices soaring. A lot of customers would become unable and unwilling to afford the Linguine alla Diavolo at Lucca. Wednesday would no longer be Prince Spaghetti day and we would sorely miss the echoes of Mrs. Martignetti calling “Anthony, Anthony!!” If the management of Lucca could not convince diners to switch to potato based gnocci it is possible the business could not survive. If they went out of business, shareholders using get nothing in the liquidation.
The risks related to committing all your assets to a single stock are greatly reduced by purchasing widely diversified mutual funds. With any investments there are always risks, but Wicked Smart Investors only take compensated risk. It is possible, but highly unlikely an individual investor would select a single stock that will beat the market over the long term and fairly compensate them for the additional risk. You stand a better chance of getting a parking spot on Hanover Street during the Feast of St. Anthony.
Speak to a qualified advisor about diversifying your portfolio then treat yourself some tiramisu.