At Henssler Financial we advise never having more than 10% of your portfolio invested in any one company. To be truly diversified, you should own 10 to 16 different stocks in eight different sectors. Diversification is a portfolio strategy designed to reduce risk exposure by combining various types of companies which are not likely to fall on hard times at the same time.
Many individuals receive stock options from their employer, matching contributions in their 401(k) plans or participate in their employer’s stock purchase plans as well as receive their income from the company. Unfortunately, many people do not properly diversify their portfolios when they receive the stock benefits from their employer. If your employer’s stock comprises more than 10% of your total portfolio, you risk losing a large portion of your retirement portfolio. If the company goes out of business, you would not only have lost wages, you would lose your savings in your retirement plan, employee stock purchase plan, and stock options.
We have given this advice to our clients since the beginning; however, we believe all investors should understand the reasoning behind this advice. The perfect example is what happened to many of the employees of Enron. Many people lost their retirement savings because of this scenario. This was a result of not being diversified. Though you may feel that your company is financially sound, there are plenty of people who put all their eggs in one basket and suffer because of it—those who worked for Enron or even the dot-coms thought their companies were strong.
When you diversify your portfolio, you are creating your own mutual fund. Many sectors are negatively correlated, so if one sector of the market has a downturn, typically another sector remains either stable or goes up. When you are over-weighted in one stock and it has a downturn, you could lose a large portion of your portfolio. While we are always hopeful the downturns recover with time, it may take years.
If you own stock options with your company and receive matching contributions in your 401(k), we suggest that you do not participate in the company stock purchase plan. If you feel you need to participate in the company stock purchase plan to be politically correct, invest the smallest amount possible. Another option is to find out if you can direct the company’s matching contributions to other investments in your 401(k) plan. For more information regarding this topic, please contact us at 770-429-9166 or [email protected].