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Advice to a Young Investor

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One of my former students sent me an e-mail message this morning. In summary, he wrote that he's been looking at the common stock of a certain company with an eye toward buying some shares, and he wants to discuss the matter with me before he makes a buy decision.

Although he wasn't in one of my finance classes, in every business class I teach, I cover the folly of investing in a single stock; however, my lectures on that particular topic often don't sink in for students in more general business courses. In the case of this bright young person, though, I have an opportunity for yet another of those much-valued "teachable moments" about stock investment, and I want to share it with a wider audience, cautioning those who don't know my teaching style that I am blunt, to the point, and quite impatient with those who want to take anecdotal issue with what I have to teach.

Modified and extended for the audience reading this article, below was the gist of my response to the young petitioner.

Good morning. I am glad to hear from you and appreciate you reaching out to me on a matter as important as personal investments. I must warn you that I do not—in fact, I cannot—give investment advice, but if you're interested in using that security you mentioned as a learning experience in the field of investment analysis, we can meet, and I'll walk you through some important aspects to consider before making your investment decision.

I remind you, as I said in your class on at least a few occasions, that investing in a single stock is a bad idea walking around on stilts because of the large amount of non-systematic risk you will bear in so doing. In review, "non-systematic" (that is, "diversifiable") risk is the component of price volatility in a security that can be removed by holding that security in a portfolio with other securities. The individual securities in a "diversified portfolio" cancel out a part of each other's price swings, leaving only an underlying volatility common to all of the securities. An investor cannot expect a reward for bearing risk that can be removed through responsible investment; hence, no investor should expect a reward for the non-systematic risk that inheres to single-stock investments.

In plain English, stock markets offer no reward for investment stupidity, and throwing money at stocks without keeping portfolio balance in the center of your decision-making workflow is stupidity with sparkles and pony rides.

Most of the ups and downs in the price of a stock (that "price volatility" thing I mentioned above) are just noise that turns normal people into nervous wrecks and turns more deeply troubled souls into day traders.

Before we even talk, you need to think about the security you're considering in the context of a diversified portfolio and what, more generally, you are trying to achieve though your financial investments; otherwise, regardless of the extent of analysis you carry out on that stock, you're investing in a lottery ticket, and investments in lottery tickets are not among my areas of expertise.

Whether or not that former student will actually come to my university office, I cannot say. He might not want to hear about diversified portfolios, and he might not want to talk about responsible investments, especially in the context of larger goals he has with respect to money, his long-term life plans, and all that. After all, he’s only about 20 years old, and, at that age, big dreams are worth talking about, but how to make those dreams come true is, quite honestly, pretty darned tedious.

On the other hand, he might e-mail me back and ask for a time when we can meet.

Young people are always surprising me with what they do, these days.

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