(EDITOR'S NOTE: WITH THE NASDAQ AND ESPECIALLY TECH STOCKS TAKING SUCH A DRAMATIC DIP, WE THOUGHT THIS ARTICLE FROM BILL STEINBERG WOULD MAKE A TIMELY REPRINT. IT IS FROM THE MARCH 22, 2000 ISSUE.)
It usually happens on Monday morning. A client calls me to discuss an investment idea he has heard about over the weekend. A friend had shared a selective memory of his latest Internet stock, bragging how he more than doubled his money in a short period. "Bill, shouldn't we reconsider buying some of that compelling Internet stock for our account?"
Investing in individual Internet stocks is an unnecessary risk that most investors should avoid. But that's not what the client wants to hear. Apparently it's not what the world wants to hear either.
The financial planning process can be boring when compared to the thrills and spills of day trading. I remind my client of recent stories of day trading gone awry. How one ruined, vindictive man walked into his investment firm in Atlanta and opened fire on everyone, eventually killing himself. And how another initially successful day trader gave up his career in Chicago to pursue stock trading full time. When his fortunes finally turned he was totally wiped out. He decided to push his wife down a ladder in hopes of collecting on her $500,000 insurance policy. When the fall didn't kill her, he attempted to strangle her until the police arrive.
The client I'm talking to knows the specific reasons why he and his wife are investing and how much they need to reach certain financial goals. My job is to help them achieve their goals with a slate of investments that aspires to capture the greatest possible return commensurate with their pre-determined risk tolerance.
The primary lesson about the volatility that accompanies high-risk investments cannot be repeated often enough: In seeking extraordinarily high returns you must be willing to expose yourself to a large and often untimely amount of risk. Being in the wrong place at the wrong time, you can lose your shirt -- and possibly more.
Remember the iceberg in the Titanic saga? It's common knowledge that the majority of the mass of an iceberg is submerged under the sea. It's only the tip that can be seen by the naked eye at a distance.
The only people who should trade Internet stocks, or any individual stocks for that matter, are the ones who are only using the "tip of the iceberg" of their aggregate net worth. Under the surface, all the financial goals of these wealthy individuals have been secured, out of harm's way. They are, in effect, choosing to speculate with money they can afford to lose.
But what about the rest of us? For a number of reasons, mutual funds with technology company exposure are a better alternative to handle this risky business. A technology or Internet mutual fund will hold a position in hundreds of stocks at any given moment. These stocks are selected by a professional portfolio manager who lives and breathes the technology sector. That person is likely backed up by the mutual fund company's internal research department who helps the portfolio manager decipher buy and sell signals.
The diversification of holdings achieved within the fund lowers the risk to some degree. Think of it as an elevator suspended by many cables instead of just one.
Individual Internet stocks, particularly of those companies like Amazon.com, which have yet to turn a profit, are extremely difficult to understand in terms of whether the current market price is over- or under-valued. Watching the classic models of stock valuation, based upon dividends and earnings, fall by the wayside is unsettling. Even the average holding periods for certain actively traded Internet stocks like AOL dropped to well below one month. At every turn, it seems investors are being challenged to prove that they can discriminate between speculation and investment.
Another point of consideration concerns the sought-after initial public offerings (IPOs) of start-up Internet companies. These "hot issues," offered only by prospectus, are nearly impossible for smaller investors to purchase in significant amounts. The mutual fund companies, by virtue of their huge purchasing power, are treated as institutional investors by the underwriting syndicate. They merit sizable allocations of these hot performing stocks which, in turn, helps to boost the fund performance that their shareholders enjoy during good markets.
Purchasing individual IPOs can be risky. Some issues drop in value immediately. Even those that soar after they begin to trade publicly on the secondary markets can subsequently drop precipitously in value.
Take, for instance, VA Linux Systems, which went public at $30 per share on December 9, 1999. Midday the share price rose as high as $320. By the end of the first day of trading, the shares closed at $239.25, up a record 690 percent. In the months that followed, the VA Linux shares have steadily declined to a price currently hovering around $105.
For all the profits that were taken, there were thousands of unlucky people who bought in too high, didn't sell rapidly enough, or went "bottom fishing" too soon.
When a client calls to discuss a particular Internet stock, the outcome has always been the same -- the spur of the moment idea is dropped. My client either opts to purchase additional shares of technology mutual funds they already own or venture into other mutual funds with an even more focused Internet company exposure. Sometimes they choose to do nothing.
In the process, we share a few laughs about the nature of greed, while reiterating the profound, real-life reasons why people invest. Most importantly, the discipline of limiting their aggregate technology stock exposure to a minority portion of their overall investment portfolio is never violated.
William I. Steinberg, CFP, is a registered representative with Financial Network Investment Corporation, Member SIPC. You can e-mail him at firstname.lastname@example.org.