When corporations make mistakes, they get punished. This comes in the form of a massive stock price drop.
Of course, if you own stock in that company, you get punished, too.
Take the case of the former darling Netflix, which drove away subscribers through a series of increasingly bad decisions over the past few months. In July, Netflix’s share price was about $300. This week, it hit $77. That’s almost a 75% drop from earlier this year. Ouch.
So, what exactly happened?
Falling Off the Cliff
It all started when Netflix announced in July that it would be raising its price by 60% for customers who wanted both streaming and DVD services. The outcry rang across the internet, with many customers threatening to stop their subscriptions altogether.
(To find out why Netflix might have made such a decision, read why corporations do what they do.)
Investors watched the hullabaloo. Many decided that Netflix wouldn't be as valuable if so many users actually unsubscribed—and revenue and profits would likely drop. Based on that prediction, they sold their shares. Cue stock drop number one.
Next, on September 15, Netflix announced that it expected 600,000 of its 25 million subscribers to leave. Cue stock drop number two.
Then, two days later, Netflix announced it would spin off its DVD service into a separate business and website called Qwikster—which would cause existing customers to buy a separate plan. Tens of thousands of Netflix devotees were outraged. Cue stock drop number three.
After that, Netflix panicked and quickly reversed its plan to split the services.
Finally, Netflix announced on Monday that even more subscribers had quit than expected, about 800,000, and that it expected more to cancel moving forward. Investors’ worst fears had been confirmed. Thus, stock drop number four, all the way down to that rock-bottom $77.
Playing It Smart
While it's too early to tell if Netflix’s stock price can be salvaged, this story nonetheless holds a lesson for us as investors: Diversify your portfolio. If you’d invested a lot of your retirement savings in Netflix (which was a savvy and growing company until this summer), you would have lost nearly 75% of your investment.
Meanwhile, if you’d invested only 5% of your portfolio in Netflix and spread the rest across a wide variety of industries and companies, you would have lost only 3.7% of your total. Much less painful.
The whole stock market tends to go up over time, but anything can happen to individual corporations. You can safeguard your investments by spreading everything across a wide range of companies. Or, to do this more simply, you can invest in a mutual or index fund.
(To learn more about mutual funds, read this.)
The bottom line: If you want to sleep well at night, have a good mix with many different investments in your portfolio.
Image credit: billaday on Flickr