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Buying Individual Stocks

is Risky Business

If we are being completely honest, we have to admit that life is full of moments where we catch ourselves thinking or even saying—“if only.” As investors, this temptation is particularly challenging because of all the facts and data, served up daily by the infotainment machine, to feed the “if only” beast…

…if only…I would have bought Apple stock when it came out

…if only…I would have bought that Google stock years ago at a fraction of its current price

…if only…I would have bought LinkedIn

…if only…I would have bought Facebook (well maybe not)

The IF ONLY’S can go on and on and on.

As we dream of a world where mega-riches seem to come from speculating a small amount of money in a cool, hip startup--it is a good cognitive reminder that true wealth is grown more reliably with a slow, steady steel-stomach discipline.

These anecdotal tales of the statistical outliers in stocks are more akin to lightning strikes. To the prudent observer, they should serve as a reminder that chasing the potential reward of concentrating wealth in a few individual stocks is exceedingly risky; often devastatingly so. Tyco, WorldCom, Global Crossing, Enron or Bear Stearns ring a bell?

Ballentine Capital Advisors 3451 Pelham Rd, Ste 100 Greenville, SC 29615 (864) 322-6046 www.ballentinecapital.com

IMPORTANT DATES:

July 4, 2014

Independence Day - Stock Market Closed

BCA - A CLOSER LOOK:

Maximizing Social

Security

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And even though individual stock analysis makes exciting headlines to bolster titillating content for financial television shows, forsaking them for a more measured, albeit seemingly boring, investment strategy tends to provide a greater probability of long term success.

What makes individual stock investing more risky than a broad market, diversified, structured, passive approach to investing?

Simply put, it is next to impossible to diversify the inherent company-specific risk of individual stocks. Individual stock prices are impacted by a host of risks: competition, management challenges, technology innovation and pressure, governmental regulations, industry sector risk, lawsuits, accounting errors. Of course, each individual stock bears more or less of each of these. Spreading those risks among hundreds of issues doesn’t eliminate the individual risks assumed, but doing so lessens the potential impact of devastating or significantly negative long-term impacts on your portfolio.

As financial author Ron Ross writes in his book The Unbeatable Market:

“Firm specific risk (which, you’ll recall, is the same as business risk and diversifiable risk) is the prime example of uncompensated risk. Insofar as securities markets are efficient, there is no payoff for taking specific risk when investing in stocks. Virtually every form of active management, every strategy having the objective of beating the market, involves uncompensated risk. It would be difficult to overstress the importance of this issue. This again illustrates why market efficiency has such important implications. “

This firm specific risk can be diversified by owning a broad market portfolio made up of individual stocks of various asset categories or classes.

Ross continues:

In an efficient market, there’s no advantage to investing in individual stocks as contrasted with a diversified portfolio of stocks. Why not? When you invest in an individual stock, you expose yourself to at least three times as much risk, but with only the same expected return as compared to investing in an index fund. The only way to make excess returns on individual stocks is by reliability identifying mis-priced stocks, and if markets are efficient, that can’t be done with any consistency. The only logical assumption is that every stock is priced such that it has a rate of return equivalent to those of other stocks carrying the same level of risk. That’s the equilibrium the market is always heading toward.

There’s a world of difference between a temporary loss and a permanent loss. The money you invest in an individual stock can go down and out. Not so with a diversified portfolio.

The highly important, practical implication is this: when you invest in an individual stock you take significantly more risk (at least three times as much), but you get the same expected return. When you invest in an individual stock or a sector fund, you take a risk for which you get nothing in return. That’s the essence of uncompensated risk.

When you get tempted to chase a hot stock or start to feel enticed by the talking heads of the financial press, there is a high likelihood that you own whatever stock they’re touting among the hundreds contained in your prudent, already-diversified portfolio.

In closing, CBS News published a story about the infamous stock picker Jim Cramer called “A Statistical Look at Jim Cramer’s Skill Level.” Among their findings:

“Specifically, on Nov. 20, 2012, Jim Cramer's urgent message was to exit two stocks immediately -- Hewlett Packard (HPQ) and Best Buy (BBY). Fast forward six months and three days through May 23, 2013, and how did these two stocks do? Well, considering Hewlett Packard was up 115.62 percent, while Best Buy gained 124.64 percent in total return, you be the judge.”

http://www.cbsnews.com/news/a-statistical-look-at-jim-cramers-skill-level/

Bottom line: Assuming concentrated and unnecessary risk to chase low-probability rewards is a great description for what happens in Vegas: It is gambling, not investing.

Have a great weekend.

Physicians Make & How to

Avoid Them

Is College Worth It?

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© 2014, Efficient Advisor. The opinion in this post is that of the author and may not reflect the opinions of Efficient Advisors or any of its affiliated companies. This post is not to be construed as investment advice or guarantee of investment return.

GOLF TIP OF THE WEEK:

Stop Shanking

Golfers often shank with their wedges because of the open

clubface and steep path of the swing needed to use the club

properly. The technique increases the risk that you will hit the ball

with the hosel – the part of the club where the shaft is secured.

To avoid shanking, let your arms hang down naturally from your

shoulders and hinge at the hips, pushing your rear backwards

and giving yourself space between arms and body. If you pull

your hips and rear in when swinging, you’ll bring the hosel too

close to the ball, risking a shank.

Tip courtesy of Steve Atherton, GolfTEC | Golf Tips Mag

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RECIPE OF THE WEEK

:

Lobster Rolls with Corn and Celery

Ingredients:

Serves 4

4 cooked lobster tails (about 1 1/2 pounds total), cooled

2 tablespoons unsalted butter, at room temperature

1 cup fresh corn (from 1 ear)

2 stalks celery, diced

1/3 cup mayonnaise

1 tablespoon fresh lemon juice

Kosher salt and black pepper

4 potato buns split

Directions:

1.) Using kitchen shears, cut through underside of each lobster tail, splitting them in half and pulling apart to expose the meat. Remove the meat and chop coarsely. Transfer it to a large bowl.

2.) Melt 1-2 tablespoons of butter in a heavy-bottomed skillet over medium heat. Add the fresh corn and cook 2 to 4 minutes until tender. Add it to the bowl.

3.) Mix the lobster and corn with celery, mayonnaise, and lemon juice. Toss to combine the ingredients. Add salt and pepper to taste.

4.) Spread each potato bun with butter and toast until golden. 5.) Fill each bun with lobster salad.

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Recipe adapted from Charlyne Mattox | RealSimple.com

HEALTH TIP OF THE WEEK:

Use Organic Ketchup to Get More Lycopene

Lycopene, a nutrient with important disease-fighting properties, is

found in tomatoes and tomato-derived foods. Researchers from

the USDA compared lycopene levels in over a dozen ketchup

brands and found that organic ketchup contains as much as

three times the amount of the antioxidant as nonorganic brands.

Although there are no concrete recommendations on daily

lycopene dosage, eating a lycopene-rich diet has been shown to

be beneficial to long-term health.

Tip courtesy of AARP

The articles and opinions expressed in this newsletter were gathered from a variety of sources, but are reviewed by Ballentine Capital Advisors prior to its dissemination. All sources are believed to be reliable but do not constitute specific investment advice. In all cases, please contact your investment professional before making any investment choices.

Securities through Triad Advisors, Member FINRA/SIPC. Advisory services through Ballentine Capital Advisors, Inc.

References

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