Few things are more thrilling for investors than finding out a highly successful company is about to hold an Initial Public Offering (IPO). Simple rumors seem to push them into frenzied anticipation, which only builds as they are confirmed. Dizzy with excitement at the potential of tethering oneself to the fate of a powerful company, as it bursts forth into the world of public trading.
Just look at the excitement surrounding recent rumors that Snapchat hopes to raise as much as $4 billion in an IPO early next year, potentially valuing the company at $25 to $35 billion.
That’s a lot of really big numbers. So should you be eagerly watching Snapchat’s IPO too, with nest egg in hand?
As you might have guessed, our answer is no. All that money could turn anyone’s eyes into dollar signs, but chasing “easy” millions doesn’t fit into a disciplined, measured approach to investment.
The important thing to keep in mind is that you’re investing for the long term. While the present moment carries with it the inevitable uncertainty of the market, your goal is to invest for the life that you want to live and achieve those things that are personally valuable to you.
We are always looking to help investors like yourself accomplish these goals by building the right portfolio for you. We believe the most reliable approach is to look at the evidence and determine the best way to capture market returns with your personal risk tolerance in mind, while minimizing tax and trading costs.
Simply put, IPOs don’t fit into that plan.
The Big Picture
Picking out individual stocks is inconsistent with the aims of long-term investing. It’s the difference between wildly shooting in a general direction and placing the target for your aggregate wealth directly in your sights.
In a New York Times article from 2012, Nobel Laureate economist and founder of Modern Portfolio Theory Harry Markowitz, was interviewed about the then-upcoming Facebook IPO.
Markowitz wasn’t a fan of buying into the IPO, and the article’s author summarized why:
“The math behind [Markowitz’s work] is complex, but the basic thought is not. Rational investors ought to assemble rigorously diversified portfolios of stocks and bonds with a mix of risk and return optimized for their own needs and beliefs. … Forget about individual stocks like Facebook and buy broad low-cost stock and bond index funds instead. Allocate them in a proportion that gives you a level of volatility with which you are comfortable.”
Replace “Facebook” with “Snapchat” and you have our thoughts exactly.
A Zero-Sum Game
One reason purchasing IPO stocks is such a gamble is that in order for one investor to “win” with their stock trade, someone else has to lose. Purchasing IPO stocks is a zero-sum game, and the possibility of being caught on the wrong side of the line means a considerable amount of risk.
Historically, the most highly sought-after IPOs are generally very narrowly offered. Only a very small group ends up getting the returns they’re hoping for, and you’re not very likely to be among them.
Their returns have to come from somewhere, and that somewhere happens to be the pockets of anybody buying their high-priced trades, which could very likely end up being you.
A portfolio-focused approach to investing opens up a different realm of play, one with far better rules for its players.
When your focus is building a portfolio with low-costs and global diversity that matches your own goals and personal risk tolerance, you’re ready to start capturing any returns the market is offering. When the market experiences growth, you and everyone else who is focused on the long term will benefit from that growth.
Speaking Of Evidence: You Better Think Twice
So what happens if you do manage to buy and hold an IPO during that early rough patch, with the hopes of long-term payoff? Isn’t that the fast road to riches? Actually, the evidence seems to show the odds are against you with any IPO.
- Larry E. Swedroe gave a thorough explanation of the latest academic insights into disappointing IPO performance in his piece, “Why IPOs Underperform,” for CBS MoneyWatch in November 2012.
- Remember Groupon? Carl Richards warned investors to “Think Twice About That ‘Hot’ New IPO” at the time, saying, “What often gets lost when we get all excited about a hot new IPO is the pesky fact that most of the time buying an IPO is a great way to lose money.”
Is It Snapworthy?
Looking to the evidence that scholars have produced in order to create and cultivate a portfolio for the ages might not be much to write, or “Snap,” home about. However, if your plan is to achieve your financial goals, I’d say those Snaps can take a back seat.
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