I want to invest 90% of my savings into stock market and split between 4-6 stocks. How risky is this and is it a bad idea. I feel like the stock market goes up over time so unless something like 2008 depression happens again there is actually not that much risk?
Note that I'm trying to turn this into a form of income and not simply getting decent returns for retirement etc. I am okay with reasonable risk so I can work less hopefully.
Investing in only four to six separate stocks is immensely risky. Depending on how you pick those stocks, there's a very real chance you'll lose the majority of your investment. Of course, if you pick the right stocks, you may do very well for yourself. But it's very risky.
What's much more common is to invest in an ETF or a low-cost passive mutual fund that tracks an entire stock market. Then, your investment is spread across perhaps hundreds of different stocks. If you want to lower your risk further, you may want to split your investment between stock ETFs (or mutual funds) and bond ETFs (or mutual funds). A conservative split might be 40% bonds, 60% stocks. A more aggressive split, with higher expected returns in the long term, would be 20% bonds, 80% stocks.
How risky is this and is it a bad idea.
It is very risky; whether it's a bad idea is more subjective.
I feel like the stock market goes up over time
This is true, but it's true for the stock market in general, not as true for given individual stocks. Amazon has massively outperformed the market over the last ten years, but Snapchat has lost half of its value in the last year.
Many people are fond of cherry picking the best stories ("If you invested in Apple in 1980, it would have increased 44,200%"), but ignore plenty of others ("If you invested in Commodore[1] in 1980, you would've lost all your money"). Looking backwards is easy. Looking forwards is much more difficult.
This is why diversified index funds are recommended so much. You're not going to outperform the market...but you're not going to underperform it either.
like 2008 depression happens again there is actually not that much risk?
It is guaranteed that something like 2008 will happen again. The last ten years of stock market growth have really been anomalous, and compared to historical trends, we're overdue for a correction (but have been overdue for a correction for awhile, and in the meantime have been receiving good returns, so...)
[1] A PC maker who was a competitor to Apple at the time.
As others have noted, investing all your money in a small number of stock is risky. If you don't have enough money to invest in a broad range of stocks -- and I'm sure experts would argue over how many, but say at least 20 companies in different industries -- then you're better to invest in a mutual fund or something similar.
Personally, I have a relatively modest amount of money, about 10% of assets, invested in individual stocks. Mostly this is just a play pen to see how well I do at picking stocks.
I have another 5% invested in a couple of very conservative mutual funds. I think of this as my "savings account". I picked funds that don't go up all that much in good times, but don't lose much in bad times. Basically in good years it goes up maybe 5% and in bad years it loses 1%. I ran this account down getting my daughter through college. Now I'm building it back up again.
And then the bulk of my money is in two retirement funds, which are higher risk but higher return. I'm willing to tolerate short and intermediate term losses here because I have a few years to go until retirement. The biggest account, the fund manager automatically shifts to safer investments as I get older.
Seeking Alpha says that the four most profitable S&P subindices in 2007-2016 were:
- S&P 500 Consumer Discretionary Index
- S&P 500 Consumer Staples Index
- S&P 500 Health Care Index
- S&P 500 Information Technology Index
So let's say that you somehow figured that out in 2006 and bought stocks in each of those sectors. You might choose
All of those individual stocks lost money except Estee Lauder, which had a return about as good as bank certificates of deposit.
And what if you did not pick the four most profitable sectors? The same article identifies the two worst sectors as financial and energy. What if you had picked
Or for a more famous example from a different time period, what about Enron?
There are ten or eleven sectors in the stock market. The general advice is to pick at least two or three stocks from each. That way, if one happens to flounder, the rest can pick up the slack.
As a general rule, we recommend picking mutual funds or exchange traded funds (ETFs). With these, you put only a small amount of money in any one company. This reduces your risk, as the market as a whole goes up most of the time over a sufficiently long period. You can further reduce your risk by having some of your money in bonds or real estate. However, remember that your house is real estate, so when calculating exposure, you should include your house.
The point of investing in individual stocks is not to get a guaranteed return but to try to beat the market. Most people won't. Individual stocks are riskier than broad-based funds. So be careful with that. Don't invest money in individual stocks that you can't afford to lose.
TL;DR: four (or even six) stocks is not enough diversity to guarantee a positive return.
There are a lot of issues to consider in your overall financial picture before considering what you do with 90% of your savings.
Do you have an emergency fund to cover 6 months of living expenses?
Are you funding a retirement account?
Is your income steady and reliable?
Are your expenses manageable and stable?
Do you have any large expenses planned (e.g., buying a house)?
Have you paid down any high interest debt?
Do you have adequate insurance coverage (car, house, health, life)?
If your answer is "No" to all of these, then putting 90% of your savings in individual stocks is incredibly risky. You might need that savings at any time, and you risk having to pull it out when the market is down. In fact, you'll almost certainly need it when the market is down, because that's when bad things happen (you need cash), and it's also when the best buying opportunities exist (you want cash).
On the other hand, if you have an emergency fund, a well-funded retirement account with maximum contributions, a steady job, low living expenses, a mostly paid-off house, no debt, and good insurance, then the risk is manageable. You have enough stability with the rest of your finances that you can probably ride out the ups and downs.
However, keep in mind that even if you are in a position to invest 90% of your savings in stocks, it's still probably better to go with a low cost index fund than individual stocks. If you enjoy the volatility and mental effort of picking and managing your stocks you might enjoy the individual stocks as kind of a hobby, but it's hard to beat a low-cost index fund.
Putting 90 % of your savings into less than 10 stocks is extremely risky.
If you don't know much about how markets work and stock picking strategies, go with mutual funds / index funds. You may not beat the market but you will be ahead of inflation.
If you are confident in picking stocks and want to invest in individual stocks, invest in at least 15 to 20 stocks, across different sectors. This will diversify your risks enough, without diluting your returns too much.
This is what my portfolio looks like:
With this, I am certain that if tomorrow market crashes (you never know), all of my savings won't disappear.
This is still quite concentrated though, considering that 60% of my money is in stocks. Ideally, you should diversify across market instruments as well.
I feel like the stock market goes up over time so unless something like 2008 depression happens again there is actually not that much risk
You are right in that over a 30 year time period, market will go up. But that's for the entire market, not every individual stock. You are also wrong in thinking that another crash like 2008 won't happen again. Historically, major crashes like that of 2008 have happened roughly once in every 10-15 years (we are due for one now). But minor crashes (10% drop) happen once every 1-2 years. No one, not even Warren Buffet, knows with 100% certainty what the market is going to do tomorrow. What do us, mere mortals, know ;).
The real question is, can you hold on onto your stocks (do you have enough confidence in your stock picking), even when they are down 50% because of any arbitrary factor?
You seriously need to define what you mean with Risky here. And I am not joking - different people have different types of appetite for risk. For example, for me Futures are not risky - Risk management is something I live in, so I can control the volatility. I also am around 40% invested in strategies with a volatility that would likely make 90% of the people here vomit every night from fear, and I have done ridiculously well with them in the past.
This may sound like a non answer, but look at it like this:
Which of those is more risky? Which is more risky for 4-5 different investments?
Risk is VERY relative.
Also, who are you - and where are you in your life? 5000EUR is... not a lot for me, a year savings for others. You may be 60 with this being a part of your free cash, or 23 with this being your first savings - which you CAN lose without long term effect. Heck, if you are young in a decent profession, ignoring the stock market and going all in on cryptocurrencies may be a low risk approach. Yes, you may lose it all, but if you are 19, software developer with a 60k EUR income you can risk it without a high risk for your personal wealth.
The question really can not be answered like that - it is way too vague.
All the answers so far are saying that investing in "4-6 stocks" is risky. That's not necessarily true. It depends on the stocks.
Stocks with low beta are less volatile and essentially track (or theoretically inversely track) the market.
Also, it depends on how correlated the individual stocks are. Stocks are less correlated when they the companies do business in different countries, different sectors, or are traded in different currencies.
Some ETFs and indexes do not give you diversification so much as the illusion of diversification. A lot of indexes are heavily weighted towards one sector. Large cap growth ETFs are heavily invested in technology stocks for example.
That said, if you're worried about risk, you should probably not be buying 4–6 individual stocks. You should be buying a broad ETF or a managed fund.
I did that when starting investing. I had only 5000 EUR to invest and divided it between 4 stocks, 1250 EUR each, to avoid high commission fees. The poor negative return was so depressing that I avoided buying more stocks for a year or so, meaning I probably lost some of the time value of money. I was somewhat lucky because the maximum amount of losses was only 30%, meaning there was still 70% of value left. And this wasn't loss due to market index: the market index went up, the value of my portfolio went down.
Now I switched to a different broker that has a 1% cap on the commission, meaning I can purchase even 100-400 EUR of a single stock, with 1-4 EUR commission. Much better now.
If you decide to purchase only 4-6 stocks, I recommend buying stocks of companies whose products you purchase. Do you use electricity? Purchase some hydropower stocks. Have a car? Purchase some stocks of oil companies, or stocks of the automaker who will be making your next car. Or maybe purchase some stocks of a tire manufacturing company.
The reason buying stocks of companies whose products you purchase is less risky for you. If the popularity of the products increases, allowing the company to jack up prices, you lose, but the company wins, and you win an equal amount you lost if you have calculated the appropriate share of ownership correctly.
Now my only large investments are in a hydropower and nuclear power company (I need electricity), oil company (I need gasoline for my car) and bank (I need their services like a mortgage). The rest are typically well below 1000 EUR per company.
A friend of mine always says, it's not about return on your money, it's return OF your money.
Others have done a good job of pointing out that staple companies do fall and fail. GE is a great example of a 100 year old staple of the american economy. It's a high quality highly diversified long term dividend paying always recommended never going anywhere blue chip that has lost ~50% of its value in the last 12 months. It's very plausible for you to have chosen GE as one of your four to six companies.
With that in mind, using 90% of your wealth to buy four or six companies specific companies from the S&P 500 probably isn't significantly more risky than buying an index ETF like SPY or VOO; but it is a terrible idea. You're probably not much more likely to lose your principle investment than you are in a market index. The issue is you are substantially more likely to underperform the market. The S&P 500 is roughly the average performance of the 500 largest companies in the US. The odds of you choosing the six of those 500 companies that will out perform is low over a long period. It's simple math. If the market experiences a down turn, the index will post a loss and your four or six companies will probably also experience a loss. In an index you'll experience the average loss, not GE's -50% specific loss. I happen to have some GE, at it's current price I still haven't experienced a loss (though it's close), I still have all my original capital, but I did watch it fall from it's recent high and subsequently have lost what would have been a gain if I'd just bought SPY with that money.
Do you really want to have 15% (1/6 * 0.9) of your wealth attached to the performance of Netflix common stock? That's a terrible idea, if for no other reason than you are likely to under perform the index over the next 10 years.
If you have sufficient stable savings and emergency funds, and you want to pick individual companies, and you want to watch the market, and you can sleep on down days, then I'd say take 5% - 10% of this money and earmark it for some individual companies, but put the lions share in to a low cost index fund. Take the market average for a low cost with the bulk of this money.
