What Facebook Stock Just Reminded Us About Risk

Facebook stock dropped 20% in a day on Wednesday. This chart of its stock is worth at least a thousand words.

Facebook Stock

And while a full technical analysis this isn’t, I share the chart and the story to illustrate a point: risk is risky, but not as risky for some as for others. Huh?

Facebook represents a growth stock (read more about this is in the upcoming print version of the Steward newsletter). Facebook does not pay a dividend to its shareholders, so they’re choosing to reinvest more money back into the company’s growth, unlike say a Proctor & Gamble who has paid a dividend to shareholders every year since 1890. Facebook’s growth pursuits have rewarded investors and fueled an enormous base of Facebook users, a very valuable asset. But if Facebook is such a ubiquitous and successful growth company, why did its stock drop so much so fast?

In an oversimplified summary, we can say that growth investors expected a LOT from Facebook. When the company chose to invest in some non-growth initiatives, doing some non-growth-company things, the market punished its stock. To put it another way, investors want growth companies to do growth company stuff and nothing else.

So why does this matter to retirees and people nearing retirement? For one, a 20% stock price drop in a day is brutal and will test investors’ reasons for keeping the stock. Long-term investors will likely hold on, short-term folks may not. In a larger sense, this should serve as a reminder that investing in many (not all) growth companies as a retiree in your core portfolio may present an alignment problem. First, companies that pay dividends – and thus are pursuing a less growth-oriented strategy – are often more stable investment choices for a person or couple seeking consistent income from their investment portfolio. Own enough dividend-paying companies and you can generate a consistent, reliable income stream to pay your bills without having to sell shares of stock to do it. However, if a large part of a portfolio is invested in Facebook-like growth companies and the growthsegment of the market falls out of favor, emotional factors set-in and retirees get spooked. This is not ideal.

Facebook’s bad day serves as a great reminder to investors that when a growth company begins to have enormous growth expectations placed on its stock price, even the smallest setback can send a stock price into a free-fall. This causes greed to turn to fear overnight. And when we’re trying to maintain a sleep-filled-nights retirement experience, these moments can run very counter to the objective.

Who knows, by the time you read this, Facebook’s stock may be back to its previous high and all is well. Or maybe this signals to the broader market that perhaps growth expectations have grown too fast and these growth companies (Facebook, Google, Netflix, Amazon, Apple) simply can’t deliver on the story that growth investors wanted to believe was true. If a retiree’s financial security is built upon these companies, bad things can happen.

The big idea here is to consider the nature of your portfolio relative to your objectives. If you have lots of time and patience, growth investments may meet your objectives; conversely, having less time before needing the money and less patience with a finicky market may mean less growth-oriented companies should be your thing. It always comes down to meeting objectives, and Facebook’s stock price drop should signal to investors a gut-check.

Finally, only the highest risk portfolios that Fourth Dimension clients may have are exposed to companies like Facebook. The vast, vast majority of our families are invested in portfolios that are income-focused and utilize more dividend-paying companies. If you told us that you’d like to swing for the fences, Facebook may be in your portfolio. Chances are, if you’re not sure, then you don’t own Facebook (or much of it) directly.

The ‘Investing 101’ formula looks like this:

1. Align your investments with your objectives,
2. Measure performance against those objectives (not against ‘the market’), and,
3. Sleep well at night knowing the world won’t come to a halt because of a single stock’s bad day.