Should You Buy That Hot Stock?
Why asset allocation should guide your investment decisions.
Whenever someone asks me, a fiduciary, fee-only investment advisor, whether or not they should invest in an individual company’s stock, my response is always, “How does it fit into your portfolio’s asset allocation?’ That question is usually met with a squinted, side-eyed glance that says, in no uncertain terms, “What are you talking about?” Allow me to explain.
What is Asset Allocation?
Investopedia defines asset allocation as, “…an investment strategy that aims to balance risk and reward by apportioning a portfolio's assets according to an individual's goals, risk tolerance, and investment horizon.” Stated another way, asset allocation is the appropriate mix of stocks, bond and cash in an individual’s portfolio given the investor’s net worth, age and risk profile.
The goal of the asset allocation is to generate the greatest return given an investors risk tolerance. An investor can take calculated risks with a certain equity positions in the portfolio, but may want to offset that risk with a more conservative allocation of the rest. This trade-off allows the investor to participate in the upside of the risky assets, but temper the downside risk with the conservative assets.
The riskiest assets tend to have the highest rate of return. When an investor hears about a hot stock, it is usually the result of the stock’s recent exceptional performance being trumpeted via the news or social media. The FOMO is palpable. Unfortunately, the potential risks are never discussed. So, when I am asked about a hot stock, my question about how it fits into an investor’s asset allocation seems to come out of left field.
An Easy Way to Ensure Proper Asset Allocation and But That Hot Stock
If all of this sounds a little confusing, there is a specific type of fund that can take the guesswork out of asset allocation for many investors - target date funds.
Target date funds typically invest in mutual funds that owns thousands of securities, both stock and bonds. The closer the current date is to the fund’s target date, the more conservative the asset allocation will be. For example, a 2050 fund will have a much higher equity concentration than a 2025 target date fund.
There are a lot of target date fund providers. If you decide this offering is right for you, you may want to evaluate each of the providers based upon their costs, returns, and years they have been open to investors. The cheapest, highest-performing and longest running funds should make for a solid investment option. And given the significant number of stocks that the target date retirement fund is invested in, it may just hold that one stock you were interested in investing in the first place.
Conclusion
In today’s world of clickbaity news headlines of “You need to own this stock now!” and “How to make millions on just one stock!”, it is important to approach investing in a disciplined, systematic fashion. Investing is one thing, gambling is another. High-flying companies are always compelling. But it is important to understand how investing in a risky stock will affect your overall portfolio. If you own a target-date fund, there is a good chance that one of the mutual funds has a position in the heralded stock. So next time you hear people talking about that hot stock, you can confidently state that you own it. The fact that you own it along with a thousand other companies can just be your little secret.
Kick rocks, FOMO!
About the author:
JP Geisbauer is a Certified Public Accountant and a Certified Financial Planner ®. He is the founder of Centerpoint Financial Management, LLC, a retirement planning, investment management, and tax planning firm located in Irvine, CA. If you have specific questions regarding your situation, please schedule a complimentary 30-minute call here.
Disclaimer:
This article is for general information and educational purposes only. Nothing contained in this article constitutes financial, investment, tax, or legal advice. Before taking any action on any topic discussed in this article, please consult with your financial planner, investment advisor, tax professional, and/or attorney for advice on your specific situation.