Let’s continue my 10-part series with a topic near and dear to my heart, the need for “diversification.”
“I’m going to load up on company stock – since I work there, I KNOW what’s going on.” Yep, that’s exactly what many, now former, Enron employees said to themselves in the 1990s as they plowed everything they had into the company. Inadequate diversification is one of the biggest risks that investors can face. And, there is no better example of the dangers of betting your financial future on one company than Enron. It’s been awhile, and our memories tend to be short, so here’s a recap:
Ironically named America’s “Most Innovative Company” for six years in a row by Fortune Magazine, Enron’s management lived up to the company’s perennial title by orchestrating one of the largest accounting frauds in U.S. history. After reporting a $618 million quarterly loss, news came out of a formal investigation by federal regulators in 2001. The publicly-traded company’s stock plummeted from $90 to just twenty-five cents per share within fifteen months! Twenty thousand Enron employees were terminated. Many had been deducting 15% from their paychecks to buy Enron stock in their 401ks. There were even stories of some employees mortgaging their houses to buy more Enron stock! Remember, these folks KNEW what was going on because they worked for the company. Well, despite their intimate knowledge of Enron, even long-term employees were duped by the company’s management (just like everyone else on Wall Street).
“If this one investment works out, I’ll be all set.” Enron is just one story of inadequate diversification. There are many more and they don’t just involve stocks. After a lifetime of hard work, some investors jeopardize everything trying to hit a final “home run” with a real estate deal, business investment, or some other all-in gamble. Don’t you do it. I’m not saying that you shouldn’t invest in your employer’s stock (or even another “hot stock”), just don’t let it become your only investment. I generally recommend against more than 5% of your total investment portfolio being in one company’s stock. You’ll also want to shift your thinking from Return on Investment to Return of Investment. I think twenty thousand former Enron employees would agree with me.
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