Buy the haystack

Nvidia continued its meteoric rise by becoming the biggest company in the world by market cap last week. This is a company that most people had never heard of a few years ago. Its share price five years ago was $3.79 and it is trading at $135.58 today. Imagine you had invested $10,000 at $3.79? You’d have $357,731 today!! If only it was that easy.

Identifying the winners

First you have to identify the companies that are going to be blockbuster winners. Which is easier said than done. First of all, you have to identify the companies when they are cheap. I spoke to a client last week who bought Nvidia at $8 (he sold his position a while ago). His research into the company was nothing more than ordering a processing chip for his computer and a Nvidia one arriving. It ran better than the other processing chips that he previously had so he bought some stock.

You couldn’t have bought Nvidia five years ago for it’s AI market dominance because that position didn’t exist five years ago. So there has to be a large dollop of luck in identifying these companies when they are cheap.

How much to invest

After identifying the next blockbuster stock, you then have to decide how much money you are going to invest. To put all your investable money into one stock is a massive risk. For every Nvidia there are hundreds that go nowhere and you end up losing it all. There are no guarantees that you are going to succeed, so you have to assess the risk.

When to sell

When you buy a stock, especially one that does incredibly well, you have to have a sell point. When is that? In March this year, Nvidia was trading at $94.29. Three weeks later it was trading at $76.20. Was it going to fall further or go on a run to the current price of $135.58? Who knows? 🤷♂️ If you had bought at $3.79, you would have been very tempted to sell and take the gain.

Or look at Peloton. Five years ago it was trading at $25.24. Its share price went up to $162.72 and is now trading at $3.79. At what point from that rise to massive decline do you sell or do you hold out? This is where behavioural finance comes into play too. Selling it, you confirm to yourself that you bought a loser and people don’t like to admit that to themselves. Many people will hold onto Peloton hoping it will be bought out and there will be a bump in the share price.

…Or buy the haystack

Instead of trying to find the needle in the haystack, you could just buy the haystack. Buying a diversified portfolio of stocks is pretty easy.

  1. You won’t buy the stocks at super cheap prices as stocks have to meet certain criteria to be considered to be included in an index.

  2. That means you are less likely to have losers too as they are established companies.

  3. You can put all of your investable money into the index, knowing your money is spread out amongst hundreds of different companies.

  4. The index itself will buy and sell stocks. You don’t have to make any active decisions on whether to sell or not. You sell the index when you need the money.

Trading in individual stocks is a lot of work and involves an element of luck. Investing in an index is outsourcing all that work to someone whose job it is to capture the returns of the market and you can go about living your life.

 

Steven Barrett

24 June 2024