This post by Jill Schlesinger originally appeared on CBS' MoneyWatch.com.
Thank you, BP. Here again is an opportunity to review a few fundamental rules about investing.
1) Avoid individual stocks: the nearly 50% plunge in BP's stock price since the Gulf oil spill, in addition to yesterday's suspension of the dividend, is further proof that for most investors, individual stocks are rarely worth the risk.
Recently, I got into a bit of a verbal jousting match with a financial "pundit," who was extolling the virtues of teaching young investors how to buy and sell individual securities. I was called "elitist" because I maintained that it was nearly impossible to properly diversify a portfolio with less than $200,000. And even if you have a million bucks, what makes you more likely than a mutual fund manager to beat a relevant index? Seems they can't do it-after fees and taxes, most managed (or hedge) funds don't beat the relevant index fund. Standard & Poor's assembles this data each year and as of the end of 2009, across all categories, with the exception of emerging market debt, more than 70% of active managers have failed to beat benchmarks.
2) Don't buy company stock inside your 401 (k): Um, does anyone remember Enron? Employees who purchase company stock inside their 401 (k) accounts are asking for trouble. BP employees have lost $1B in their 401 (k) plans because they probably saw an investment in the company stock as a good deal. As of last September, 29% of BP's total 401 (k) assets were in BP stock!
Investor take-away: don't fill your 401 (k) with company stock. If your company matches in the stock, make sure to sell that position on a regular basis to keep your allocation in check.
3) Don't Try To Catch A Falling Knife: Let's say you ignore Rule #1 and feel compelled to jump into a stock that is in the midst of a significant collapse. To wit: a few weeks ago, I received a question about buying BP stock at $38-ish. The argument was: hey, the stock is down from over $60 and look at Exxon after the Valdez fiasco! At the time, I said that we really don't know the extent of BP's liability, so buying the stock would be akin to "catching a falling knife."
Investor take-away: If you are tempted to gamble on BP stock, go to your nearest casino instead-at least you'll get a free drink!
Jill Schlesinger is the Editor-at-Large for CBS MoneyWatch.com. Prior to the launch of MoneyWatch, she was the Chief Investment Officer for an independent investment advisory firm. In her infancy, she was an options trader on the Commodities Exchange of New York.