When volatility rocks one of your stocks, you’ve got a choice to make.
Do you do what Bill Ackman did back in October with Valeant Pharmaceuticals (VRX)?
Or do you do the smart thing?
In truth, Ackman has made two blunders with regard to Valeant, the scandal-tarred drug maker.
First, many months ago, he allowed his enthusiasm for the company to get out of hand. Reportedly, he funneled nearly 20% of Pershing Square’s assets into that one stock.
I’ve cautioned readers, over and over through the years, never to let a single stock occupy more than 5% of your portfolio. In today’s unstable financial environment, I would lower that limit to 3% or even 2%. You simply can’t afford to permit one company to blow your fortune to smithereens.
Ackman made his second mistake October 21. Charges of dodgy accounting had already knocked Valeant stock way down, and Pershing’s position was under water. Ackman decided to buy two million more shares, reasoning he had only two options available: “sell everything if there’s material fraud because the shares will go to zero, or buy now while the stock is a bargain.”
Of course, there was a third choice: Do nothing. But Ackman couldn’t accept that option, because his first mistake (overcommitting to one stock) had put enormous psychological pressure on him to do something dramatic (sell everything or buy more).
We don’t yet know how the Ackman/Valeant story will play out. Bill Ackman may prove to be the luckiest guy on the planet. Alternatively, he may end up destroying billions of dollars of wealth—for himself and his investors.
That’s the risk you take, and the price you may have to pay, if you fail to diversify properly. As the late Sir John Templeton (a far wiser man than Bill Ackman or any of today’s hedge-fund crowd) said: “The only investors who shouldn’t diversify are those who are right 100% of the time.”
Don’t pull an Ackman! Make sure to diversify.
