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With some stocks soaring to record highs, you might have been tempted to double down on a favorite selection, such as: Tesla or the last IPO.
However, at least one money expert is sounding the alarm that some investors may be overexposed to individual stocks.
Christine Benz, director of personal finance at Morningstar, said she vowed to speak next time potentially dangerous market conditions emerged after the dotcom bankruptcy in the late 1990s.
“It feels like this time is here,” she said tweeted last week.
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A sudden stock pullback could lead to a “painful outcome” for some investors, Benz said, especially those approaching retirement who have lost sight of the risk they are taking.
Investing in stocks is an uncertain bet, even for experts.
Over the past year, the contrast between what is going on with the market and the world at large has seemingly increased. As the Covid-19 pandemic sparked a sharp economic downturn, record unemployment and 400,000 deaths in the US, stocks rose.
Many Americans have increased their stakes in companies, especially names they know. In 2020, the top five stocks bought by TD Ameritrade customers were among the top five Apple, Microsoft, Tesla, Pfizer and Boeing.
For investors, the market environment has been “a double-edged sword,” according to JJ Kinahan, chief marketing strategist at TD Ameritrade.
“You have to be careful, especially when we are at all-time highs,” Kinahan said. “But if you’ve bought every Dip game in the past few years, your success has been unprecedented in many ways.”
The appeal of these potential gains has drawn people in who have more time and money to spend during the Covid-19 pandemic, Benz said.
Additionally, there is a group pressure factor that makes some people feel like they don’t want to miss out, she said.
“That excitement is often greatest when ratings are high,” Benz said.
Take Tesla, for example. On Wednesday, the stock was trading at nearly $ 850 per share. However, Morningstar estimates the fair value to be just over $ 300 per share.
As in the days of the internet boom, there are some compelling stories that spark interest in individual companies, Benz said. But just because a stock is up 700% doesn’t mean it’s another 700% gain, she said.
It’s not exactly a repeat of the ’90s equity craze, but the high-stakes risks are similar.
“In such an environment, some of the newer, inexperienced investors tend to get burned,” Benz said.
Some investors may build portfolios that contain only Tesla-like names.
“This is where I think investors can get into trouble,” said David W. Karp, co-founder of PagnatoKarp Cresset.
Amazon is a company that survived the dotcom bankruptcy. But the stock has always been high-priced, even in 1997 when it was trading for “outrageous multiples of sales,” Karp said.
Cisco Systems, another example from that time, has seen sales and earnings increases since then, but the share price has not.
“The business grew into the valuation, but the valuation just didn’t expand,” Karp said.
The examples highlight an investing truth: “There are a lot of great companies out there that may not be great stocks,” Karp said.
It’s okay to own some of these company names, Karp told clients.
But ask yourself a few key questions: What am I buying? What am I investing in? What is my dollar buying for me?
One way to avoid big losses is to limit the risk you take in the first place.
“If you want to use individual stocks, think of them as a Mad Money portfolio,” Benz said. “But use your real money for a reputable and diversified, balanced portfolio.”
Mutual or exchange-traded funds with broader exposure to multiple stocks can be helpful, especially with regard to long-term goals like retirement.
It is also important to observe how overexposure can occur.
Kinahan says investor portfolios get out of whack in two scenarios – when a stock is doing really well and outperforming, or when a newer investor does not have enough capital to diversify.
One way to avoid regrets is to be careful.
For example, if new companies enter public markets, an IPO might not do as well as expected, Kinahan said.
“You don’t have to invest on the first day,” Kinahan said. “If it’s a good company, your options will be many.”
Also, upgrade as much as you can in a company or fund before investing. At TD Ameritrade, the use of the company’s training tools was three times higher in 2020 than last year. And there is always room for education, Kinahan said.
“I would like to see people do this, especially those who are newer,” he said.