Sunday, November 04, 2007

Stupid Financial Advice

I was traveling on business this week, in various parts of the country. On Thursday morning, I was having my breakfast at a Holiday Inn Express and casually watching a morning show somewhere in North Carolina, when I heard some extremely stupid financial advice coming from the TV.

The show contained a stock market segment in which the financial correspondent covered the recent run-up in Google stock. She commented that the stock just crossed the $700 mark. The anchor, impressed, asked if there were any plans to split the stock. The financial correspondent explained that Google's philosophy was to encourage serious investing rather than trading, and so had no intentions of splitting the stock. Here is where the stupid part begins. The following is not an exact quote, but it's pretty close:

Anchor: "If you only have a small amount of money to invest, how can you get in on the Google game?"

Financial Correspondent: "as a small investor, you can save your money and buy a single share of Google. Google has been showing such impressive results, that you would be better off buying a single share of its stock than buying more shares in weaker companies".

I am sorry, but if you do not understand the basics of investing, you have no business going on TV as a financial correspondent and misleading small investors.

What's wrong with that exchange? Well, for one thing, it assumes that Google's impressive past performance will continue into the future. Just because a stock, a mutual fund, or even the market as a whole has shown impressive results in the past, there is absolutely no guarantee that it will continue to do so in the future. In fact, assets have a tendency to "regress to the mean". If something has shown a dramatically faster appreciation than the overall market in recent years, it may be due for several years of under performance. That is the reason why investors should re-balance their portfolio by selling some top performers and buying some laggards. What the financial correspondent suggested is known as performance chasing and is a great way to ensure that you get burned financially.

There is another fundamental problem with the financial correspondent's advice. If you only have enough money in your portfolio to buy a single share of Google stock, the resulting one share portfolio is completely undiversified. From that point forward, your portfolio's fate is completely tied to the fate of a single company. This is a very risky proposition, regardless of how strong you believe the company you invested in really is. If you only have a small amount of money to invest, do yourself a favor and buy a diversified index fund instead of a single company stock. Vanguard's Total Market Market Index fund (VTSMX) may well fit your needs.

5 comments:

plonkee said...

Presumably, the correct answer would be to buy a mutual fund that holds some google stock. Pundits are there to entertain, not inform sadly.

Chief Family Officer said...

Maybe it's the lawyer in me, but I don't have a problem with that answer because it directly answers the question - although Plonkee makes a good point. The expert certainly could (should) have added the caveats you suggested, but those wouldn't have answered the question asked (insert "nonresponsive" objection).

Shadox said...

Well, my main concern is with the second part of the statement:

"Google has been showing such impressive results, that you would be better off buying a single share of its stock than buying more shares in weaker companies".

You are right that the first part addressed a direct question.

the Prince of Thrift said...

maybe the small investor should buy Google by using ShareBuilder.com --- this how I own a small piece of 1 share of Berkshire-Hathaway B stock. (Unfortunately they won't sell the A shares - but I can say I own some of Warren Buffett's company - eve if it is the class B shares). In a way I am saving to buy the 1 share, but doing so by actually putting that savings into the stock. A process that will be accelerated when I get my debts paid off.

Shadox said...

The difference between Berkshire and Google, is that Berkshire is a diversified conglomerate that gives you exposure to a wide range of industries and business, while Google is still a very specific and undiversified organization (the vast majority of their revenue comes from advertising, as you know).

I personally would not invest large amounts of money in a single company stock, even if that company is Berkshire. There are simply too many factors that could bring the stock down even if the market itself remains risilient. For example, if Warren Buffet stepped down, are you 100% confident that his successor would be able to repeat Buffet's truly amazing performance?