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Archive for Sunday, October 30, 2005

Google offers lesson in investing

October 30, 2005


Why didn't I invest in Google?

When the Internet-search company announced in the spring of 2004 that it would sell shares to the public, I warned that the stock could be pretty risky. Two months later, Google said each share could be priced as high as $135. I said that was too high.

I was pretty pleased with myself the next month, when the sale was done at only $85, and I said even that seemed a bit hazardous. But in the following two months, the price soared above $170. OK, I wrote, but now it's really too high. I was still mouthing cautions after the shares climbed above $215 last April.

On Thursday, the company reported stupendous earnings results, and the stock soared to $340. And I don't own a single share. (The only reason I'm not tearing my hair out: I wouldn't buy stock in any company I write about, anyway.)

Lucky or smart?

What lesson can we sideline-sitters take from Google's rise?

Let's back up. A financial planner once told me that all his rich clients got that way from a big bet on a single stock. This is probably true of most of the big fortunes - those of the great international traders of the age of clipper ships, the railroad barons of the 19th century or the Bill Gateses of the 20th.

On the other hand, any list of bankrupts also would have a disproportionately large share of people who put all their eggs into one basket.

Granted, lots of folks made a bundle on Google. But were they smart or just lucky? Surely, those who merely followed the fad were just lucky.

What about the pros? Many studies have shown that over time professional stock pickers cannot consistently beat the broad market's performance.

During the past 12 months, mutual funds that invest in science and technology stocks have gained just a little over 7 percent, while Google has gained about 130 percent, according to fund-tracking company Lipper.

If Google was such an obvious play, why didn't these pros pile enough of it into their funds to do better? Perhaps some had a lot of it but lost money on other bets. That suggests they're not stock-picking geniuses.

If the pros can't spot hot stocks, can you?

And even if you think you can, are you willing to do enough work? To have a well-diversified portfolio composed of individual stocks, you'd have to own at least 20 different ones. Keeping up with the press coverage and government filings of 20 companies would take hundreds of hours a year.

And you might have to research 10 times that many stocks to find the ones you wanted - a full-time job.

Alternatively, you could choose a fund whose managers have done better than the average. But how would you know if it was luck or skill? To evaluate them, you'd have to be as good as they are - and funds don't disclose enough about their trades to make such an analysis possible.

Do diversify

Investors who focus on individual stocks face mathematical headwinds.

On average, an individual stock is twice as volatile as the broad market - its up and down price swings are twice as extreme. High volatility undermines compounding.

Imagine you had an investment that routinely rose 30 percent one year and fell 10 percent the next. That's roughly a 20 percent gain over two years, or 10 percent a year. Not bad.

Now imagine you had another investment that rose by 10 percent every year. You'd think the two would provide identical gains over time.

But no. After 20 years, $100 put into the more volatile investment would grow to $480, while the less volatile one would mushroom to $673.

Reason: As the two investments grow, the big down years at the volatile one get more damaging.

The lesson from Google: It's so rare it may never happen again.

Sure, if I'd put every penny I had into Google, I'd be ready to retire today. But I wasn't planning to.

Instead, I'm happy with a simple set of index-style mutual funds that match the overall market's performance and don't try to run laps around it. That way, I don't risk the kind of wipeout a single stock can cause - and I'm pretty sure I'll be able to retire when I'm ready to.


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