Five years after Enron, people still donít get it.
The problem is holding too much of your portfolio in one stock. Often this occurs because you work with a company provides stock options, discounted stock purchase plans, awards in restricted stock and the opportunity to load up in your 401(k) through employer matches in stock and the ability for you to buy more. All it takes is enthusiasm for what you do and a blind faith in the company and the wheels are set in motion. The corporate ďkool-aidĒ is within you and you start loading up.
If you are one of those people, here are ten reasons why you better think twice:
10.) It costs you more financially because of the risk you are taking. A concentrated position requires over-funding for goals and excess ways to insure because there is always the risk that the stock will go down at the wrong time. What if the stock tanks right when you are retire, you are about to pay for your childís college education or if you passed away with a family to support?
9.) People hardly recognize the risk in the above; so they rarely ever do anything beyond the norm to protect themselves. It may be within their risk tolerance, but they donít have the capacity to bear the financial risk.
8.) ďEven the best companies will drop 50% every 20-30 yearsĒ Ė Warren Buffett. There are many great companies trading right now at half their value from their latest peak. Look at a majority of banks.
7.) Concentrated stock positions are analogous to refusing to wear your seat belt when driving a car. This is uncompensated risk. It takes little time and effort to diversify this risk and have so much to lose.
6.) If your company somehow defies gravity and goes to infinity, you can become rich with it being just 10% of your portfolio.
5.) Eighty percent who make their wealth due to a concentrated person lose their wealth because of a concentrated position.
4.) Not only do you hold risk in your investment assets, you have risk in your career asset. So if the company does well, you donít necessarily have to stuff all your investment assets in the company as your career should expand with the success of the business. What if the company goes under? Not only did you lose a significant portion of your life savings, but you now are also unemployed.
3.) Adelphia, Enron, Worldcom, Delphi; need I say more? Also you are not immune if your company is private either: remember Arthur Andersen?
2.) OK, I will say moreÖÖ..International Harvester and Bethlehem Steel: both were members of the Dow at one point. Where are they now?
1.) If the stock tanks, your significant other will never let you hear the end of it. Not any financial cost here, but being reminded about it for the rest of your life wonít be worth it.
The problem is that people who hold concentrated risk are essentially gambling, not investing. And the excuses run right down the sleeve why it wonít happen to themÖÖbut it eventually will. It may not be today or tomorrow, but you only need to be wrong once in the next twenty to thirty years. Thatís a long time to be always right.
Well at least you canít say that you havenít been warned.
Of course Iím being sarcastic here, but the economic stimulus legislation expected to be signed by President Bush will create little economic stimulus; short or long term.
The centerpiece of the legislation is a rebate check of $300 per person if you make less than $75K or $600 per married couple if you earn less than $150K. Then you would get a rebate of $300 for each child. It even extends to some who donít pay taxes. The rebate is a gimmick. The government is hoping that everyone is going to go on a shopping spree, but letís be real here: How much is it going to help the economy? If they are deficit spending, shouldnít the government treat this spending like an investment; deploying it where itís going to generate a return on investment in the form of higher economic growth, which in turn creates long-term tax revenues that exceed the original investment?
The second part is accelerated depreciation for businessís that make capital expenditures. This may encourage some additional business spending, but again, I think this doesnít have teeth as businessís usually plan out their expenditures over time according to needs; if the economy is slowing, is it really going to create a splurge in capital spending: I doubt it.
The housing measure would make it easier to finance or refinance mortgages for larger homes and in more expensive housing markets. Now this may help a bit, but I donít see this reinvigorating the housing market either.
If Washington was serious about creating a package that had long term staying power, they would:
-Make the individual marginal tax brackets from the 2001 tax act permanent (with some adjustment to address the alternative minimum tax as discussed below).
-Lower the corporate marginal tax rates. When profit margins shrink, what do companies do first: they begin laying off their workforce. Lower taxes would at least increase the margin where companies have to make that decision. It would also allow them to better contend with their competitors overseas.
-Make the qualified dividend and long-term capital gains rate permanent. Even though the national savings rate is a debatable measure, I still think America as a whole does a pretty lousy job at savings for tomorrow. We need to maintain some sort of incentive to invest. Instead, these rebates are being handed out because Washington wants you to spend.
-Kill the Alternative Minimum Tax (AMT). This was originally intended for taxpayers who made over the equivalent of one million dollars a year back in the early 70ís. Now it encroaches on the middle class, especially in high tax states like Maine, which increasingly puts us at a disadvantage to lower tax states. Although Iím not a subscriber of the tax the rich mentality as I think itís a cop out, but why not have a higher marginal tax rate for those who make over a million that will offset the lost revenue of the AMT? I guess Congress doesnít want to lose their campaign contributions. But I would watch this very carefully; the AMT was a lingering problem that Washington decided to ignore and patch. This could play out similar to how our Social Security system is played out in the years to come.
Agree or disagree with me, but if Congress was really serious about long-term economic health, this legislation wouldnít be happening. And itís amazing how duplicitous the fiscal restraint proponents on Capital Hill are so willing to hand this out like candy in such a bipartisan manner no less. You would think this is an election year. Oh right, it is.
In my last blog, I discussed the latest market turmoil and how you should be approaching your investment strategy in the correct manner: From a long-term perspective. Short-term market myopia and not having your priorities in order only leads to the big mistake.
How can you turn this current market environment into your favor? These are the things that can work to your advantage:
-If you have excess cash to fund toward retirement plans, there is no time better to invest like today. As mentioned before, stocks are on sale now at discounts to what they were several months ago. So if you were planning to make your 2007 retirement plan contributions before April 15th, there is no time like the present to complete this. You may even want to fund your 2008 contribution as well if you have the extra cash and are certain you will be eligible to make a 2008 contribution. For those waiting on the sidelines for things to improve, donít waste your time trying to time the market. Since most of the pronounced gains from a market recovery occur right after the bottom, by the time you decide that itís OK to go back into the market, usually you end up missing more in the form of gains than the amount you saved by avoiding the market in the first place.
-If you are under a periodic investment plan, this allows you to continue to dollar cost average your investments at lower and lower prices, which will allow more stock to be bought with higher return potential. This is a tortoise and the hare analogy, which can be just as boring as watching paint dry, but cost averaging works nicely in a down market.
-Systematically rebalancing portfolioís will re-coup losses by buying at discounted prices and amplify future returns. This strategy is simply selling high and buying low. So for example your targeted asset allocation is 60% stocks and 40% bonds; due to the markets, now itís a 50/50 split. This is simply selling enough bonds and buying enough stock to return to this 60/40 allocation. For people in their working years, you can sell out of some of todayís out-performers and replace it with laggards or rebalance using new funds. For the retiree who needs cash flow, it can be simply selling bonds or safe assets now after years of culling stock off as it appreciated during the bull market.
-Tax Loss Harvesting: For those who have taxable accounts, the rise in the stock markets has created a situation where mutual funds have run up large gains over the last five years. In turn, many mutual funds issued large distributions last December, when reinvested this increases the cost basis of the stock. This coupled with the losses this month now have a lot of holdings trading at a tax loss. There is a way to turn lemons into lemonade. This is done by tax loss harvesting, which simply involves selling a holding at a loss and re-investing it in a similar, but not identical holding. As a result, this allows you to take a tax loss that you can use against your taxes or offset future gains and in turn, the portfolio allocation stays the same. I would however, check out IRS Publication 550 in regard to Wash Sale Rules to make sure you are correctly doing this.
In the end, the greatest risk isnít what the markets do; itís what you as the investor does. Acting on oneís emotion and selling at market lows is absolutely the best way to guarantee that you have lower returns and reduce your chances of achieving your financial goals along with that. Nobody likes to see the stock market go down, but if there was little risk of loss, then we wouldnít earn superior long term returns that stocks have to offer as we wouldnít be compensated as much for the lower risk.