To get everyone up to speed, an IPO, or initial public offering, is when a company sells stock for the first time. This is also called “going public”.
In a nutshell, the original owner(s) of the company sells ownership to the public in the form of stock.
For example, when Tesla went public in 2010, Elon Musk (and the other owners) decided to sell a portion of the company by going public. Now anyone can own a portion of Tesla by buying its stock.
And if you would have bought Tesla stock at its initial price of $17, that same stock would now be worth almost $880 at the beginning of February 2021.
The Numbers Don’t Lie
The problem however, with investing in IPOs is that Tesla is an extreme anomaly. Whenever you have a Tesla who has seen tremendous growth, you also have thousands of other companies that do poorly or fail completely.
According to some studies, more than 60% of IPO’s lose money over the first 5 years and others have mediocre performance. Only a very small percentage do extremely well like Tesla, Facebook, or Amazon.
So in a nutshell, investing in an IPO is often like buying a lottery ticket with a very low chance of winning big. The potential upside is huge but so is the potential downside.
For average investors like you and me, we are much better off investing in diversified portfolios that have a long track record.
Whenever I talk to those that are interested in IPOs I often caution them to not invest any money that they aren’t okay without. That way, regardless of what the IPO does, it doesn’t affect their long-term goals. And if the IPO ends up doing well, it becomes icing on the cake.