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 There are so many ways to lose money investing that if you stick around long enough, you may experience many of them. Losses are more frustrating when they come out of nowhere. A recent example is the Toyota saga. During the bad old days of the 1970s, manufacturers such as Toyota and Honda began to offer really small, but fuel efficient and reliable cars here in the U.S. To a nation stunned by oil shocks that sent the price of gas through the roof and caused rationing (eg: if your license plate ends in an odd number, you buy gas on an odd-numbered day of the month), these cars were the perfect antidote.
Over the decades since, Toyota has progressed so methodically that it was just yesterday that it was set to take the hard-earned title of "World's Largest Vehicle Manufacturer" from beleaguered General Motors. With 14 manufacturing plants in North America and 33,400 Americans employed, Toyota is the closest to an American car company as a foreign manufacturer can get.
So respected have become the methods Toyota uses to manage its business that they've been given a name: the Toyota Way. In fact, a cottage industry has sprung up to document the Way and apply it to everything from marketing to motivating employees. (If you have a minute, see what you can find searching the Internet for the Toyota Way).
Therefore, the saga that has unfolded since the fall of 2009 regarding Toyota has been a shock to nearly everyone. Coming to light is a story of cutting corners on safety in order to keep up with growth, of a company losing sight of what made it special. Defective Toyota cars have left a wake of deaths, recalls, lawsuits, Congressional investigations, embarrassment and bad press.
There is a lot we can learn from this story. First, we should identify the type of risk that Toyota investors are being bit by. While any car company can issue one, recalls of millions of vehicles over critical systems involving accelerators and braking belongs solely to Toyota. It simply cannot shift the blame elsewhere. Why can we say this? Look at its competitors. Sales at Ford, Honda, and Hyundai, among others, are up strongly as the economy comes back from the brink. Because the risk rests with how the company is being run, not surprisingly, we identify it as company risk. For Toyota investors, it's as if they chose the wrong horse in the right race.
The second issue we should address is how we as investors can avoid company risk. Realize that as the economy bottomed out and started turning upward, many savvy investors chose to invest in Toyota, the largest and most respected auto maker, to lower their risk! Now look.
Let's identify ways to address company risk:
1. Don't put too much money into the stock of any one company, no matter how much of a sure thing you think it is. The pros call this "position sizing", as in "don't let your position (ownership) of a single company be too large."
2. When you make an investment, put in place a "protective stop" that will sell your stock if it falls below a certain level. This will ensure that your losses will be manageable. Your broker will help you with this.
3. Consider broadening your perspective and investing in a whole sector (ie: a broad area of the economy). For example, if you were confident that auto sales would be begin rebounding as 2009 came to an end, you could have spread your money across several of the leading auto makers. Thankfully, in many industries there exist ETFs (exchange traded funds) that own the leading companies. For example, if you believe that technology will lead the way, you can purchase the S&P Global Technology Sector Index Fund. Its symbol is IXN. The fund holds stock in Microsoft, Apple, IBM, Cisco, and others.
There are investors out there, even high profile ones like Ben Stein, who believe that investing in individual companies is just too risky. You would be in good company if you decided that you will only invest in sectors.
There is an argument against this type of investing, however. The whole point of doing one's research is to identify those companies that are making the right moves and which will pull away from the competition in the future. The argument goes, "If I can identify one company that is really hitting its stride, why do I also want to invest in nine other mediocre ones?" (assuming that the ETF for this industry holds 10 companies). To see the growing number of sector ETFs available, visit the sites of the two leaders: ishares.com and proshares.com.
Finally, if you've check out Toyota's stock over the period from late 2009 to early 2010, you'll see that the stock hasn't been punished too badly. Your author offers two reasons for this: 1) Toyota has built up an extradordinary amount of goodwill (ie: good feeling) amongst its customers. Many have bought Toyota after Toyota after Toyota, all with great results. These customers believe Toyota will eventually overcome its problems and return to market leadership.
2) The stock market has rallied so much over the last year that investors are searching around for stocks that are good values, that haven't skyrocketed from their March, 2009 lows. Toyota is up about 25% in the year following those lows, whereas the average stock is up about 70%. To them, with nearly all other stocks up so much Toyota continues to look like a great buy.
Can you answer:
1. The Toyota saga illustrates what investing risk?
2. Identify two ways that you can dramatically reduce this risk.
3. What do we call a broad area of the economy, such as technology, healthcare, or banking?
4. What do the letters ETF stand for, and what is the purpose of one?
5. Identify two leading companies that offer ETFs.
6. What is the downside of investing only in ETFs and not individual companies?
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