Individual-Investment Risk - dummies

By Eric Tyson

A downdraft can put an entire investment market on a roller-coaster ride, but healthy markets also have their share of individual losers. For example, from the early 1980s through the late 1990s, the US stock market had one of the greatest appreciating markets in history. You’d never know it, though, if you held one of the great losers of that period.

Consider a company now called Navistar, which has undergone enormous transformations in recent decades. This company used to be called International Harvester and manufactured farm equipment, trucks, and construction and other industrial equipment. Today, Navistar makes mostly trucks.

In late 1983, this company’s stock traded at more than $140 per share. It then plunged more than 90 percent over the ensuing decade (as shown). Even with a rally in recent years, Navistar stock still trades at less than $20 per share (after dipping below $10 per share).

Lest you think that’s a big drop, this company’s stock traded as high as $455 per share in the late 1970s! If a worker retired from this company in the late 1970s with $200,000 invested in the company stock, the retiree’s investment would be worth about $6,000 today! On the other hand, if the retiree had simply swapped his stock at retirement for a diversified portfolio of stocks, his $200,000 nest egg would’ve instead grown to more than $5 million!

Even the bull market of the 1990s wasn’t kind to every company.

Just as individual stock prices can plummet, so can individual real estate property prices. In California during the 1990s, for example, earthquakes rocked the prices of properties built on landfills. These quakes highlighted the dangers of building on poor soil. In the decade prior, real estate values in the communities of Times Beach, Missouri, and Love Canal, New York, plunged because of carcinogenic toxic waste contamination. (Ultimately, many property owners in these areas received compensation for their losses from the federal government as well as from some real estate agencies that didn’t disclose these known contaminants.)

Here are some simple steps you can take to lower the risk of individual investments that can upset your goals:

  • Do your homework. When you purchase real estate, a whole host of inspections can save you from buying a money pit. With stocks, you can examine some measures of value and the company’s financial condition and business strategy to reduce your chances of buying into an overpriced company or one on the verge of major problems.
  • Diversify. Investors who seek growth invest in securities such as stocks. Placing significant amounts of your capital in one or a handful of securities is risky, particularly if the stocks are in the same industry or closely related industries. To reduce this risk, purchase stocks in a variety of industries and companies within each industry.
  • Hire someone to invest for you. The best funds offer low-cost, professional management and oversight as well as diversification. Stock funds typically own 25 or more securities in a variety of companies in different industries.