Do you dream of buying shares of the next Microsoft before they take off? How about the next Apple? Apple shares are up 4,200% over the last decade. Even better than Apple, shares of priceline.com are up almost 5,000% over the last 10 years. These are life-changing returns. A modest $20,000 investment in priceline.com 10 years ago would be worth more than $1 million today.
If only you had the foresight to identify the last decade’s winners ahead of time, you could be 10, 20, or 30 times richer than you are today.
Sound like the beginnings of a pitch you’ve heard before?
My inbox is flooded with promotions for investment services that promise to identify the next Microsoft or Apple. They all promise returns of 2,000%, 3,000%, or like priceline.com, 5,000%. The pitch is effective. The thought of turning a $20,000 investment into millions gets your heart racing. You stop thinking rationally. Greed takes over. You’ve already spent your profits before you’ve made them.
This is all intentional, of course. The promoters don’t want you to stop and think about how you are going to achieve a 5,000% return. Is it even possible to earn a 5,000% return? That sounds like a foolish question. The promotion tells you how. All you have to do is find the next priceline.com.
That is much easier said than done, but let’s say you do find the next decade’s 5,000% winner. The chances that you’ll earning anything close to 5,000% are near nil.
Let me explain. In order to earn a portfolio return of 5,000%, you would first have to invest your entire portfolio in one stock. After witnessing the collapse of AIG, the world’s largest insurance company, not to mention the debacles of Enron, Lehman Brothers, and Bear Stearns, what sensible investor would put his entire portfolio in one stock? And even if there are investors with the guts to bet everything on one stock, how many do you think would hold on to shares for the entire 5,000% gain?
But surely you can just include the next priceline.com as a component of your portfolio and still earn massive profits, right? That’s true, you can do that.
Let’s say that 10 years ago you had $400,000 to invest and you decided to put 5% of your portfolio in priceline.com shares and the balance in an S&P 500 index fund. Sounds like a reasonable strategy. If priceline.com went bust, you would only be out 20 grand. If it returned 5,000%, you would have made hay, right?
The buy-and-hold version of this portfolio would have returned 263% compared to a 15% gain on the S&P 500. That’s a compelling return, but it is doubtful that you would have bought and held this portfolio. You see, in order to earn that 263% return you would have had to hold on to all your priceline.com shares even as they grew to 30% of your portfolio six months after the initial investment and also after they became 60% of your portfolio in 2009. Today your portfolio would be invested 70% in priceline.com and 30% in the S&P 500. Does that sound like a portfolio that you would be comfortable holding?
Most investors would have taken profits on priceline.com long before it came close to representing 30% of their portfolio. I know I would have. Those 5,000% returns you read about in promotions are elusive. If you want to try to get rich quick, play the lottery. In the stock market, 5,000% returns are only achieved through the power of compounding over long periods of time.
Jeremy Jones, CFA
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