How I made 130% returns from this one stock

Familiar headline?

The headline was made to entice people to click. For many other websites, after users click, they get sold to a product, and then part with their hard earned money. How often do we see headlines such as this?

Taken from:

After visitors get hooked, they go on to put a disclaimer that goes something like this: not all our investments make money, but these are just some that do. Isn't it so easy to sell something if I can write like this too?

An half-truth is still a lie

What if I told you, the headline was not fake at all. The 110% return is an actual return, and the stock is Netflix. On 2 January 2016, the price of Netflix was $49.85, and it increased to $114.38 on 31 December 2016. This gave me a return of 130%.

However, I would have lied, because this is merely a half-truth. You see, I buy and invest into the Vanguard All-World UCITS ETF, and Netflix is merely one out of the 2,966 shares that the ETF holds. You can download the full listing: here.

When this Netflix stock is held within a portfolio, a 130% returns doesn't seem that great anymore. In fact, as a portfolio, the VWRD actually lost money. It dropped from $69.51 on 31 December 2014 to $66.49 on 31 December 2015.

By buying many stocks, there are bound to be extraordinary winners (and also extraordinary losers). However, by presenting the story in a certain manner, many commercial speakers tell the other side of the story.

Using this lie to your advantage

The other side of the story is that no extraordinary losers can materially affect the performance of a portfolio. Just like how a stock that made 130% returns couldn't improve the overall performance of VWRD by much, a similar loss would not drag down the overall performance of the portfolio.

In finance, spreading your purchase over many stocks is known as diversification. Diversification is good, because it removes unsystematic risk; that is, the risk that attributes to individual securities. Unsystematic risk do not provide more returns, only systematic risks do.

The most efficient portfolio is one with full diversification, because you only hold systematic risk, which is rewarded with returns. Holding other form of unsystematic risks make your portfolio inefficient because these risk are unnecessary and not providing any returns.

What you can do best is to hold a diversified basket of shares and bonds. It is the best way to invest.
Next Post »