“Putting all your eggs in one basket” is something we’re warned against doing in many scenarios, and investing is another in which this holds true. In the case of investing, this translates into investing in individual stocks.
Diversification Is Key
Ramsey explained that the main drawback of relying too heavily on one stock is that it exposes you to too much risk.
“The core issue here is a lack of diversification,” he wrote in the column. “When you put all your eggs in one basket, there’s always some clown twirling the basket.”
Ramsey gave the example of a 70-year-old woman who had worked for the same large company for 40 years.
“On top of that, she invested all her 401(k), all her wealth — $800,000 total — in that one company,” he said. “Well, this company experienced a crisis. It lost nearly half of its value, and her $800,000 was suddenly worth about $400,000. She left herself vulnerable with a high-risk play.”
Ramsey said it’s never a good idea to “bet the farm on the horse.”
“Don’t have more than 10% of your net worth wrapped up in single stocks,” he said. “Hundreds of research projects have been done that show individuals who buy individual stocks and think they know what they’re doing actually lose money much more often than they make money.”
This Advice Holds True Even If The Stock Seems Like a Good Deal
In the scenario at hand, an employee of a company that offers a stock purchase plan at a 15% discount asked Ramsey if he should buy the stock and how long he should wait to sell. Ramsey said that even if you get a discount, it’s always a risk to put too much into a single stock.
“Generally, I don’t recommend buying single stocks at all,” he said. “Single stocks are way too risky, and a 15% discount is nothing special in this kind of scenario. Virtually every single company out there that has an employee stock option plan offers a 15% discount.”
Ramsey said that if you crunch the numbers, the “discount” isn’t worth the potential risk.
“In most situations like this, if you pull up a 52-week chart on the stock’s performance, you’ll find a variance of as much as 15% in those 52 weeks,” he said. “In other words, you could lose any or all of that discount in one move of the stock. Plus, it’s not like 15% is a big discount to begin with. Fifteen percent off a single stock, considering how volatile they are, is no big deal. But hey, if you love your company that much, they have a great track record, and the stock has a good history, go ahead. Just don’t allow single stocks as a category to make up more than 10% of your net worth.”
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