One of my favorite lines from the book Money Code is that Jews invest in high risk assets when they are young so they can grow their wealth and then when they get older they become more conservative. This is also a principle that we teach in our investment class: Investing 101. The idea is that when you are young and have the rest of your life to earn your money back, in a worst case scenario, you should be taking as much risk as you can stomach.
A way that we teach this principle is by applying the rule that you invest in stocks according to your age. If you are 30 years old you should be in 70% stocks and 30% bonds. If you are 50 years old then you should be at 50/50 stocks and bonds. I would consider bonds and dividend paying blue chip stocks the same. Both are income driven not growth driven both are relatively stable. It is first important to understand how growth stocks work and then specifically how all this applies to IPOs which are the ultimate form of a growth stock.
Stop buying blue chips
There is no wealth in investing in something that is already proven. You might look smart for pointing at Nike or Apple or Verizon or Haynes, but you wont get rich.
You will just impress people who don’t know anything. If you are younger than 50 and you have a portfolio full of blue chips you won’t be wealthy in 30 years you will just be old. The key is to invest in growth at a young age and then shift into income producing assets such as dividend paying stocks and bonds. This is why I tell athletes to live out of the interest. They have already accumulated their wealth and are seeing the highest income they ever will. It is important to now conserve that and live out of what that money generates. That is wealth and you likely aren’t there yet. So stop it b.
When a company is brand new and not as well known you are likely to see the most growth as they become more readily accepted (read Tesla). It is also a time when you see the most volatility. Volatility looks like drastic up and downs. We have seen this in almost every IPO in the last few years.
Growth companies typically don’t pay dividends because they are using all their money to invest back into their product and expansion. To investors that look for more stability this could look like the company is a loser when in fact it is just at a different stage than a company that has been around longer. As a reward for the lack of a dividend, the growth stock prices usually fly higher because 1) there is anticipation that there will be a large future dividends and 2) it entices people to invest because the money is still coming in just through appreciation.
The number one place that we see this is in IPOs. These brand new companies are up and coming and are often times finding their way. As a result, they tend to keep little cash and high debt but all of this is invested in the future dividends paid to the shareholders. It takes time for any product to get traction in the market so it’s not wise to count out a company right when it launches. An example of this is Netflix that was a mail order dvd rental company before it turned into what it is now. Another example is Paypal that was actually an online bank before they scaled down into managing payments exclusively. The key is not to count out a company because it doesn’t look like what it will eventually look like.
I believe that we are entering the stock pickers market. Meaning that we aren’t going to see a broad sweeping market crash we are just returning to a time when certain stocks rise and others fall. This is important because we lived through a time when all stocks rose. I believe this is what is driving everyone toward index funds. Since the last years were full of the market returning to normal we saw all stocks rise because before that, all stocks fell. This made people think that beating the market is a waste of time because the market did all the work for you. That is not normal. That was merely the result of the aftermath of a huge crash. A normal stock market has winners and losers. Some win and some lose but not all do either.
I encourage you to take risk now, make sure you are picking the right stocks because all stocks don’t matter and don’t fall prey to the naysayers. Fear isn’t rewarded, courage is. Be great!