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Lottery stocks are investments that have huge potential payouts over short time horizons. However, lottery stocks, like lottery tickets most often turn out to be losers. This article focuses on ways to minimize volatility and improve returns through diversification and tempering short-term return expectations.__
The other day I was talking to a client that is 90 years old. He retired from his first career at the age of 59, picked up a second career volunteering with the sports program at a local university and is now retiring again after thirty-one additional years of service.
When he was 20 years old he had read about the stock market and decided to invest in a utility company with a $10 share price and a $1 distribution. He invested $200, set the dividends to reinvest and never sold. Today those shares are worth approximately $200,000 and produce a dividend of nearly $10,000 per year.
At first glance this seems like a crazy return on a $200 investment. But this is merely a 10.3% annual return constantly compounded over 70 years. A great return but not much more than the roughly 9.4% return on the Dow Jones Industrial Average over the same length of time. Admittedly, buying and holding something as boring as an S&P 500 index fund is easier said than done. Entire television networks, websites, and print publications are devoted to selling the dream of quick returns. Asset managers heavily market their quarterly results and highlight trading algorithms that switch between buy and sell recommendations in a few fractions of a second while newsletters promote dubious penny stocks with the promise of quick 1,000% returns. All of these things entice investors to take extraordinary risk.
- The investor that loses 50% in a stock trade needs to make 100% on the next one to get back to even.
- The investor that loses 75% needs a staggering 400% return to get back to the starting value.
My client was lucky. The stock he bought happened to survive and outperformed the market. However, if during the 70-year holding period the company went bankrupt or sold to a company that ended up going bankrupt, he would have lost everything. Had the client tried to trade the stock, getting in and out based on shifts in the market, the odds are he would have missed out on most of the gains and suffered huge tax consequences along the way.
Volatility is an amazing thing.
Rather than looking for lottery stocks, young investors can avoid a potential investing mistake by making a long-term allocation to something like an S&P 500 index fund and being patient. It will not be sexy, it will not be straight-line growth, and it will not bring immediate riches but it is a long-term strategy that is less capricious than searching for stocks, options, commodities, funds, or currencies that seem undervalued.
This article is from the five-part series on the Most Common Investment Mistakes.
Investing does not have to be complicated but far too often, individuals take risks they don’t understand, trying to outperform a benchmark that has no relevance to their financial goals. This series is focused on simple things savers can do to improve their long-term performance.