On a recent episode of The Ramsey Show, Michelle from Wisconsin told co-hosts Dave Ramsey and George Kamel about her interesting and enviable dilemma.
In 2022, Michelle made a bold move by investing a large sum — $270,000, much of which she received as a life insurance payment for the death of her husband — in the stock market. Fortunately for her, this was during a market correction. Since then, her investment has grown fourfold to $1.1 million [1].
While Michelle entered the market at the right time and picked stocks that paid off in a big way, this sudden good fortune has left her feeling uneasy. She called in to The Ramsey Show because she wasn’t sure what to do with such a large amount of money tied up in stocks, and she worried that her $500,000 in unrealized gains could evaporate in a market downturn.
Should she continue to hold, cash out or find another strategy that allows her nest egg to keep growing while reducing risk?
Ramsey congratulated Michelle on her success before quickly pivoting to the risks. Her initial investment had been in only 20 companies, and of those 20, only four had produced most of her gains.
Michelle’s situation generally follows the pattern of the stock market since the pandemic. Since 2022, the 500 biggest U.S. companies tracked by Standard and Poor’s have grown 70%, but most of that growth has been in the “Magnificent 7” made up of Nvidia, Amazon, Alphabet (Google), Meta Platforms (Facebook), Microsoft, Apple and Tesla [2].
Those seven stocks have grown 262.7% as a group, and Nvidia on its own has grown 1,027.7%.
While it may seem that the companies which represent Michelle’s four successful investments will continue to grow, Ramsey compared her situation to a gambler who put all her chips on one roulette number and lucked out. And just like in a casino, if you find you’ve won a lot, it’s probably time to leave the table and exit the building.
“What you’ve pulled off … is not sustainable,” said Ramsey. “For instance, people who are day trading — they’re buying and selling all during the day — 97% of them lose money within a year. Now, you have not been day trading, but you have been trading.”
Ramsey explained that putting all your money into a few good stocks, even if they have performed well in the past, leaves you exposed to a massive downturn if those companies falter.
“It would scare me if I woke up and half of my fortune was in four stocks,” said Ramsey. “Because as those four companies go, so goes my fortune.”
Diversification, on the other hand, spreads risk across many different investments, creating stability and reducing the chance of catastrophic losses. Ramsey recommended that Michelle sell the stock, pay the taxes owed on the gains, and then reinvest the money in a balanced portfolio.
Read more: There’s still a 35% chance of a recession hitting the American economy this year — protect your retirement savings with these 10 essential money moves ASAP
Diversification means spreading your money across different asset classes such as stocks, bonds, real estate and alternative investments like gold.
Rather than relying on a single company’s performance, you gain exposure to many different businesses, sectors and asset types. This approach reduces risk because losses in one area can be offset by gains in another.
Fortunately, we are in a golden era of diversified investing. In the 20th century, diversification in a portfolio could mean owning small stakes in dozens or scores of stocks, plus a stack of paper bonds in your safe deposit box. Now you can own almost any kind of asset — from stocks to bonds to gold and cryptocurrency — in an exchange-traded fund (ETF) that has low fees and is very liquid.
Some investors choose to balance both worlds by putting most of their money in diversified funds while setting aside a small portion for individual stocks. This strategy allows them to enjoy the thrill of picking companies they believe in while keeping their core investments safe.
For those who are just beginning their investing journey, the safest way to start is by contributing to retirement accounts such as a 401(k) or an IRA, where tax advantages can help your money grow faster. Within these accounts, low-cost index funds and ETFs are usually the best starting point. They provide broad exposure to the stock market at minimal cost.
It’s also important to invest steadily rather than trying to time the market. Regular contributions — a strategy called dollar-cost averaging — help smooth out the ups and downs of market cycles. New investors should focus on long-term growth rather than quick wins. And before putting money into the market, build an emergency fund that ensures short-term needs won’t force you to sell investments at a bad time.
Michelle’s success as a first-time investor is wonderful, and a lesson to others. Her massive gains are extraordinary, but her smartest move is to rebalance her portfolio to make sure she is diversified and protected against the ups and downs that individual stocks are subject to.
For first-time investors, her story is a reminder to start with steady, diversified investments, rather than chasing risky bets. In investing, slow and steady often wins the race.
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[1]. The Ramsey Show Highlights — YouTube. “I Made $1.1M Trading Stocks”
[2]. Investopedia. “Magnificent 7 Stocks: What You Need To Know”
This article provides information only and should not be construed as advice. It is provided without warranty of any kind.
