ACCLAIMED AUTHOR Malcolm Gladwell talks about the importance of adding “candy” to his writing. By this, he’s referring to the asides, trivia and factoids that he uses to hold readers’ interest. Gladwell is quick to note, however, that writing can’t be all candy, with no main course, just as it can’t be all main course with no candy. To be effective, he includes both substance and entertainment.
When it comes to your investment portfolio, does the same principle apply? Is there a need for candy? If you study the literature, the answer is clear: Investments that are interesting, fun or popular tend not to be as profitable as those that are simple, cheap and mundane. Investing in hedge funds, picking stocks or dabbling in venture capital? No question, those are all interesting and fun—but the odds are also stacked against you. Boring as it sounds, most people are best served by a straightforward portfolio of low-cost index funds. That is invariably what I recommend—because that’s what the data say and also because that’s what I’ve seen work best in practice.
But is that it? Should everyone just stick with boring old index funds? Is candy strictly off limits—end of story, case closed? No, that’s too simplistic and too uncompromising. I see at least three situations in which a modest amount of candy is not only acceptable, but might also be beneficial.
1. When it builds knowledge. I’m glad that my teenage children have shown an interest in investing. While I’ve given them the same advice I give everyone else—to keep things simple—they’ve learned far more from the individual stocks that their grandfather gave them, when they were born, than they’ve learned from owning index funds.
Among other things, they’ve learned what a public company is and what it means to be a shareholder. They’ve learned the relationship between corporate earnings and stock prices—and why that link often breaks down. As a result, they’ve also learned the value of diversification. Most important, it’s made investing interesting enough to hold their attention. Over the years, they’ve asked far more questions about McDonald’s and Smucker’s than they ever would have asked if they’d owned just an S&P 500 index fund. And the result is that they’ve learned a lot more. To be sure, they might have earned more holding a simple index fund, but I don’t think you can put a price on the education that they’ve received.
Another example: Last month, at the Thanksgiving table, a college-age relative told me about a stock she had purchased called Cronos. I asked if it was Kronos the software company, Kronos the chemicals manufacturer or Cronos the marijuana producer. Unfortunately, it was indeed the marijuana company. She told me that she had already lost 60% of her investment and asked what she should do.
While I’m sorry the investment hasn’t worked out, the silver lining is that it led to a productive conversation (and—who knows?—it may still work out). For better or worse, investment knowledge is built incrementally, often with some trial and error. In this case, it was a good opportunity to discuss why a growing company doesn’t always translate into a rising stock. Over the past nine months, Cronos’s revenue has tripled, but its losses have grown tenfold. My advice: If you have children, I’d buy a few index funds, but I’d also let them choose a few stocks.
2. When the risk-reward equation is clear. Every investment occupies its own place on the risk spectrum. While there’s no such thing as “guaranteed” when it comes to investing, some investments offer a much clearer line of sight to profitability than others. Some examples: a rental property with a tenant in place or a partnership stake in a medical practice. I see these as very reasonable choices and a good way to diversify.
3. When it’s a unique opportunity. About 15 years ago, when my friend Dan was in college, a handful of his classmates invested in a friend’s startup company. That friend? Mark Zuckerberg. Could anyone have predicted that Zuckerberg’s startup would turn into the behemoth that it has become? Unlikely. But it was clear, even then, that Facebook was unique and off to a fast start. To be sure, I don’t recommend betting on every 19-year-old with a startup, but it’s important to remember that some do succeed. If something looks truly unique, you don’t need to reflexively slam the door on it. In these cases, I think it’s okay to place a small bet.
Bottom line: In most cases, and for most people, I think it’s best to keep things simple, but it’s also important to avoid absolutes. Consider each investment on its own merits.
Adam M. Grossman’s previous articles include Owning Oddities, Imagining the Worst and The Unwanted Payday. Adam is the founder of Mayport Wealth Management, a fixed-fee financial planning firm in Boston. He’s an advocate of evidence-based investing and is on a mission to lower the cost of investment advice for consumers. Follow Adam on Twitter @AdamMGrossman.