Individual investors hoping to score on an initial public offering -- as did anyone who invested in Amazon.com Inc.'s 20 years ago and stayed in -- should know the odds are stacked against them for myriad reasons.
First, retail investors generally don't get in on the "ground floor" of an IPO, shares of which are typically reserved for institutional investors and insiders. Buying after the IPO isn't typically a lucrative route either, experts say, with such investors often paying a higher price than earlier, bigger investors.
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Second, many IPOs fail to live up to their promise and companies that were once hyped by Wall Street sometimes go bust. Even the success stories have down times that can test investors, including Amazon, which was down as much as 95% after the tech-stock bubble burst.
In turn, financial advisers generally don't recommend investing in IPOs. However, if all the cause for caution isn't enough to discourage IPO investments, advisers say there are a few guidelines to consider:
1) Know Why You Want to Buy
It is important to determine why, as an investor, you'd want to buy into a company's IPO, says Todd Morgan, chairman of Bel Air Investment Advisors in Los Angeles.
Is it to take advantage of a potential short-term trade? Does it stem from long-term faith in the underlying company?
If the latter is the rationale, what makes the company so great? Market dominance as well as continued faith in the company's business model and leadership typically indicate a good long-term investment, Mr. Morgan says.
As with any stock, he says, it is important to stay up-to-date on quarterly earnings, research reports and the overall market to make the most prudent investment decisions in the long run.
2) Know Your Risk Tolerance
Investing in a single stock is risky. If an investor had invested in, say, Barnes & Noble Inc. instead of Amazon 10 years ago, he or she would have had a very different outcome today, says Stacy Francis, a president of Francis Financial in New York. Unlike Amazon's nearly 50,000% gain, Barnes & Noble returned just above 50%.
Alfredo Martinez, chief investment officer at HighTower Boca Raton in Florida, tells clients to invest only a small portion of their portfolio -- maybe 2% to 3%--into an IPO. "If you want to go to Vegas you only take what you're willing to lose," he says.
He also advises clients to not have more than 10% of their portfolio invested in any concentrated position.
3) Stick to Your Plan
Even if you are lucky enough to invest in an IPO that outperforms expectations over the long term, it is essentially impossible to know when you should buy more shares or pare your position.
Your best bet, then, is to stick to a long-term financial plan that suits your financial goals and risk tolerance, financial advisers say. This may mean selling some of your winning IPO shares to rebalance your portfolio to your target asset allocation.
Rose Swanger, a financial planner in Knoxville, Tenn., tells clients to use a limit order that instructs a broker (or clients themselves) to buy or sell a security at a specific price or better. This way, she says, clients have to think about why they want to purchase the company's IPO at a premium price and when to lock in some profits at a later time.
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(END) Dow Jones Newswires
May 17, 2017 02:47 ET (06:47 GMT)