Swinging for the Fences
Loading up your portfolio with risky, all-or-nothing stocks, is a sure route to investment disaster. In other words, swing for the fences on every pitch.
For one thing, the insidious math of investing means that making up large losses is a very difficult proposition - a stock that drops 50% needs to double just to break even.
For another, finding the next Microsoft when it's still a tiny start-up is really, really difficult. You're much more likely to wind up with a company that fizzles than a truly world-changing company, because it's extremely difficult to discern which is which when the firm is just starting out.
In fact, small growth stocks are the worst-returning equity category over the long haul. Why?
First, the numbers: According to Professor Kenneth French at Dartmouth, small growth stocks have posted an average annual return of 9.3% since 1927, which is a good deal lower than the 10.7% return of the S&P 500 over the same time period. The 1.4% difference between the two returns, has an absolutely enormous effect on long-run asset returns - over 30 years, a 9.3% return on $1,000 would yield about $14,000, but a 10.7% return would yield more than $21,000.
Moreover, many smaller firms never do anything but muddle along as small firms - assuming they don't go belly up, which many do. For example, between 1997 and 2002, 8% of the firms on the Nasdaq were delisted each year. That's about 2,200 firms whose shareholders likely suffered huge losses before the stocks were kicked off the Nasdaq.
Also read:
Compounded Effects of Market Underperformance
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