Over the past week, I've seen several articles that have discussed how individuals found incredible wealth by placing their entire net worth or all their savings in a single investment. The two mentioned most as of late are Tesla ( TSLA) and bitcoin.
We've also seen the incredible wealth created for Trevor Milton, thanks to his huge position in Nikola ( NKLA) , and this comes despite Milton -- the company's founder -- getting ousted. In fact, we can list executive after executive who has made incredible fortunes in the companies they've founded or those they lead.
There's no denying heavy concentration isn't the path to significant wealth creation. The problem for most investors, especially new investors, is when they do this with money they can't afford to lose. Or they aren't emotionally ready for the challenges that come from a concentrated position.
In reality, this is a terrible risk-management strategy.
While the reward is fantastic when you are correct, the risks are essentially as high as they get. When we see these stories about founders getting wealthy, sometimes we fail to make the distinction between investor and entrepreneur. Those individuals often invested in themselves or a team. In addition to that, they have ownership from an extremely low valuation. Often this will require they put in a ton of sweat equity or their own capital or both, but investments don't get any more ground-floor-level than that.
For most investors, they are buying into a name that is past exponential growth for years to come. There may be a year or two of exponential growth, but their best hope is for consistent growth with some acceleration. And while Tesla and bitcoin have offered that wealth creation, those investments have been exceptions not the norm even in this incredibly strong market.
Plenty of names have performed well, incredibly even, but the challenge comes in the pullbacks. If you plopped your life savings into something and it fell 20%, would you continue to hold? What about 50%? 75%? 90%?
Where's your line, your pain threshold? When does conviction become nothing more than hope?
The media will tout the rags-to-riches stories or the all-in commitment stories, because they generate clicks. The stories you won't see covered often are the ones where someone made a concentrated bet and failed. Those stories are far more common; perhaps, far too common to cover. They would discourage the dream.
Unfortunately, I'm seeing far more commitment to single names or heavily concentrated names than I'd prefer to see floating around. Even when I talk with other Real Money columnists Helene Meisler, James "Rev Shark" DePorre, or Bob Lang, I know they have a myriad of positions, despite possibly liking a few more than others. A larger position doesn't always equate to overconcentration. We might be talking about a name that is 6% to 8% of an account, not 60% to 80%.
It's great to have conviction, but remember to also maintain discipline and risk management. For every get-rich story you hear, there are likely hundreds of go-broke stories you don't. There are plenty of great trading names right now in the market, so spread your risk a bit and sleep better at night not having to ponder how you'll react if one of your positions plummets the next day.
