Understanding Stocks

After a volatile year like 2022, it may be tempting to wonder why you need to own stocks. Though most of us have a general idea how the stock market works,?Falcon Wealth Advisors?Founder and Wealth Advisor Jake Falcon, CRPC?, recently asked me to join him on?Upticks?to discuss our approach toward stocks and their place in a diversified portfolio built for growth and income. Please see a summary of our conversation below.

Jake:?A broad definition of a stock is “an ownership stake of a company.” You can buy stocks by exchanging money for a share of a company’s stock, giving you a partial ownership stake of that company. The reason companies issue shares of stock is they take the money you invested and use it to grow their business, in hopes of making the business worth more money. As a shareholder, you can hopefully cash in on that growth.

There is risk in owning stocks, of course. If a company goes out of business and you own shares of stock in it, you could lose all your money. But the idea is investing in stocks allows you to ideally grow your wealth and be able to keep up with inflation.

Why in your opinion, Cory, do you think people invest in stocks?

Cory:?Well, for many American workers, investing in stocks can be an efficient way to save for retirement. Many companies offer 401(k) retirement plans, and employees are able to invest money in these plans, which are comprised of stocks and bonds. And of course, employers?often match a specific sum or percentage?of an employee’s contributions in the 401(k) plan. It’s easier for the average American worker to invest in stocks instead of, say, real estate.

Jake:?Correct, there are many ways to set yourself up for retirement. As for me personally, I don’t want to be a landlord or invest in a business I know nothing about. Stocks on the other hand are an efficient way to grow your wealth. While it’s not?easy?to make money in the stock market, it can be easier and more transparent to invest in the market compared to other types of investments. There’s a lower barrier to entry for average people.

Regular readers know that we encourage clients not to invest any money they could need access to in the next 5-10 years in the stock market. This is because the?stock market is volatile?and stocks can go down in value, as we’ve seen this year. If you have?all?your money in the stock market and nothing in bonds or cash, you may have to sell a stock when it’s down in value to provide yourself with the income you need. Selling a stock when it’s down can do permanent damage to your portfolio—there’s no way to recoup that loss. Investing in the stock market is for growing your wealth in the long term.

Let’s now talk about two primary ways you can invest in the stock market:

• You can buy individual stocks directly, which we don’t recommend doing on your own. We believe in working with a fiduciary wealth advisor, who has experience managing individual stock portfolios, if you want to purchase individual stocks, as that advisor or their team should be constantly researching specific stocks.
• You can buy?financial products, like mutual funds and exchange traded funds, which may contain stocks. At Falcon Wealth Advisors, we don’t use products like these for many reasons—and especially because of the fees associated with them. We instead invest our clients in individual stocks and bonds directly at our discretion.

Cory:?Yes, we use individual stocks and bonds because we like to have control over how our clients’ money is invested. We know them and their families, and as fiduciaries, we are legally required to act in their best interests. The same can’t necessarily be said for a mutual fund manager or an advisor who’s?not?a fiduciary.

Jake:?Well said. Individual stocks offer more transparency than financial products and they cost investors less, as they don’t have expensive fees associated with them.

It is possible to invest on your own without the help of a fiduciary wealth advisor. If you’re going to go this route, make sure you understand any fees involved with your investment. If an opportunity sounds too good to be true, it probably is. At?Falcon Wealth Advisors, we believe managing a portfolio is a full time job. So if you would rather spend your time in retirement visiting family or pursuing hobbies, we recommend working with a fiduciary wealth advisor.

Let’s now talk about diversification. I think many investors have been misled into believing they must own hundreds of stocks to have a diversified portfolio. How many stocks do you think an investor should own, Cory?

Cory:?A simple answer: 25-35. This is according to what we both learned studying at?The Wharton School of the University of Pennsylvania. Check out this chart that shows how much risk you can mitigate through diversification. As you can see, we can’t totally remove risk from the equation. However, you can also see that the level of risk starts to level out once you’re invested in 25-35 stocks. In our clients’ portfolios, we aim to invest them in about 35 stocks.

If you look at the Dow Jones Industrial Average index, it’s made up of 30 companies, while the S&P 500 is made up of 500. Though these indexes don’t move in lockstep, they typically head in similar directions. This highlights that hundreds of stocks in a portfolio doesn’t necessarily mean that portfolio is any more diversified than one with 25-35.

Jake:?When your portfolio is diversified, you will likely own some stocks that have done well and some that have performed poorly. However, just because a stock has performed poorly, that doesn’t mean it will continue to. At?Falcon Wealth Advisors, when we analyze a stock, we do two types of analysis. The first is a fundamental analysis, which focuses on corporate earnings, company leadership and more. We also do a technical analysis, which involves looking at a stock’s trajectory and paying attention to where it’s headed.

Of course, many individual investors don’t have the time, tools and expertise to do these types of analysis. It’s human to expect a stock that’s going down in value to continue to do so, but that’s actually when you should perhaps consider?buying?more of it—assuming you believe in its fundamentals. Last year’s losers could be next year’s winners. With that said, if there is a fundamental issue with a stock we own, we are not afraid to sell it.

At?Falcon Wealth Advisors, our analysis allows us to take a long-term view and make unemotional, mathematical decisions on behalf of our clients. We diversify because we can’t predict the future. If we knew exactly which stocks were going to do well, we wouldn’t worry about diversification and simply invest in those!

Cory:?I would go so far to say that if?all?your stocks are going up in value, your portfolio probably isn’t diversified. You could buy 10 or 20 different stocks from an industry that’s currently doing well, but that doesn’t mean your portfolio is diversified for the long term.

Jake:?Exactly. We saw some investors who seemed to overly focus on tech stocks in recent years, and they are now paying a price as the values of those stocks decline.

We have three people on our team at Falcon Wealth Advisors who are dedicated to examining and analyzing the stock market day in, day out. One of them,?Conner Hanlon, CFA?, is a Chartered Financial Analyst?(CFA?).

A lot of investors may not understand that if you are constantly buying stocks that are up in value and selling stocks that are down, you’re actually opening yourself up to more risk. It’s a cliché, but we aim to buy low and sell high. Clients hire us at?Falcon Wealth Advisors?to manage risk and make unemotional, mathematical decisions as we analyze the market and their?financial plans. While we can’t predict the future, we can help prevent our clients from making mistakes that result in permanent losses.

Let’s finally discuss concentrated positions. Many of our clients worked at one company for many years and then find themselves owning a large number of shares in their company’s stock. If any stock makes up more than 20% of your net worth, it’s considered a concentrated position. We don’t encourage clients to create concentrated positions, as we have heard stories of people losing large amounts of money—and working longer than they had planned—after their company’s stock went down in value.

If you do believe you have a concentrated position, don’t panic, as it’s not necessarily cause for alarm—but it is a reason to schedule a meeting with our team. We have helped hundreds of people navigate similar situations and can help you diversify your portfolio and experience a?smoother transition to retirement.

Cory:?Yes, and the closer someone gets to their retirement date, the more important diversification becomes. If you’re younger and have a concentrated position, you have time to recover from any losses in that position. When you’re older and approaching retirement, that’s not necessarily the case.

Jake:?Indeed. There’s an old adage that says the easiest way to get wealthy is through concentration but the easiest way to stay wealthy is through diversification. With that being said, concentration is not the only path to wealth. We work with hundreds of clients who have achieved wealth in a number of ways.

Thanks for joining me today, Cory. I hope we have shown why we invest in stocks for our?Falcon Wealth Advisors?clients. If you would like to discuss how we can use stocks to grow your wealth while mitigating risk, please contact us today. You can reach us at?[email protected]?and?[email protected].

Clients choose to work with us to enhance their financial literacy and explain exactly what?their?financial plan means to?them.

Hightower Advisors, LLC is an SEC registered investment adviser. Securities are offered through Hightower Securities, LLC member FINRA and SIPC. Hightower Advisors, LLC or any of its affiliates do not provide tax or legal advice. This material is not intended or written to provide and should not be relied upon or used as a substitute for tax or legal advice. Information contained herein does not consider an individual’s or entity’s specific circumstances or applicable governing law, which may vary from jurisdiction to jurisdiction and be subject to change. Clients are urged to consult their tax or legal advisor for related questions.