Question from Quora: I don’t believe in investing in some boring stock not touching the money for years and making 6–7% a year if you are lucky. I want to pick one stock that I trust will do well and double or triple in value but has a high risk factor, is it really a bad idea if I use stop losses?
Yes, it is a bad idea. That being said, I suppose that it depends on how much money makes up your “life savings.” It also depends on how much this money means to you, and how long it would take you to recoup this money if you lost it.
No company is infallible. Even if you think a company is great and has no chance of failure, think again, and look at history.
In 2008–2009, corporate mega-powers and banks were bankrupted or acquired for pennies on the dollar. Companies like Lehman Brothers, Washington Mutual, General Motors, and Chrysler were not immune. What makes you think that your favorite company is immune? Sure, in hindsight, we can see why some of these companies were at risk. But hindsight is 20/20, and few if any saw the Great Recession approaching.
With government bailouts, some of these companies were ultimately restructured and are still around today in some capacity, but if you were using stop losses, you would automatically be giving up on the company after the stock value declines by a certain amount.
To me, this approach sounds more like gambling than investing.
Consider this: If hedge fund managers can be beaten by monkeys, what makes you think you’ll do a better job at picking the best stock?
While 6–7% returns may seem “boring,” Warren Buffet’s Rule #1 is: “Never Lose Money,” and his Rule #2 is: “Never Forget Rule #1.”
Consider the impact of losing your life savings and having to rebuild from scratch. I won’t go through the financial modeling exercise here, but even a 20% loss could have a very negative impact on the ultimate value of your savings — let alone losing it all — which is far from impossible when putting all of your eggs in one basket.
While, from a strictly financial standpoint, you are better off investing in multiple low-fee ETFs that represent different markets, countries, and economic sectors, if you feel compelled to invest in one company because you truly believe in that company, I wouldn’t rule it out completely — but I’d limit it to a small percentage of your life savings.
You may be limiting your gains, but in my mind, more importantly, you’d also be limiting potential losses.
Only you know your risk tolerance… but if investing in your favorite company provides you with some level of excitement, then go for it — just remember that the potential worst-case scenario is that you could lose your entire investment. Therefore, if you only invest 10% of your life savings into this one company, an unforeseen catastrophic event that puts this company out of business would only impact a small portion of your life savings.
Plan accordingly and do not put all of your eggs in one basket.