Beware Over-concentration in Your Own Company Stock

Suzanna De Baca -- Expert Business Source, 4/7/2008 7:53:00 AM

If Enron wasn’t enough of a lesson for employees who own company stock, Bear Sterns is another tragic example of how those who have not diversified their wealth sufficiently can lose a bundle in short order.  While there are many unfortunate lessons behind Bear Stearns’ catastrophic collapse, one of them is that you shouldn’t necessarily put all your eggs in your company’s stock basket.

Depending on which headlines you read, and on which day, Bear Stearns’ Chairman James “Jimmy” Cayne saw his net worth plummet from over $1.2 billion in early 2007 to just a little over $13 million a few weeks ago.  Bear Stearns’ president and CEO Alan Schwartz’s estimated losses are estimated to be over $100 million and COO/CFO Samuel Molinaro Jr. is down approximately $20 million, apparently having had less to begin with. These folks were in control of the company and were likely required to hold a certain amount of stock, but presumably they had thorough information when making the decision to hold so much.

But what about the employees who owned considerable amounts of Bear Stearns stock in their personal portfolios or in their retirement accounts?  They may have been unaware of the amount of leverage the company was employing.  They were in the dark.  They were being loyal to their employer. They believed company management; the destruction of wealth seems not only disastrous, but like a betrayal of trust to many.

But, who is responsible for making your investment decisions?  Even if you are a company employee and you believe in your company, is it wise to invest a disproportionate amount of your wealth in one stock?  Even if you are showing your allegiance to a company, doesn’t it make sense to diversify? 

Most advisors preach asset allocation over and over.  We read that over 90% of returns can be attributed to proper asset allocation, which means creating a mix of different stocks, bonds, cash or other assets.  Very few advisors suggest that overweighting one’s portfolio in a single stock is prudent from the standpoint of controlling risk;  concentration can be an effective way to grow wealth quickly if the security soars, but it can backfire if the security heads south.

So, you may ask what you should do if you own one security – like company stock – and it goes up, skewing the percentage of your net worth in that particular investment.  How can you help being overweight?  Well, in that circumstance, most advisors would tell you to rebalance, meaning you should trim that position back to a reasonable amount within your total portfolio.  But what about the upside?  Shouldn’t you keep holding such a successful position?  Well, we’re talking about how to protect the downside, here, and one of the ways to do that is to take that money off the table. Alternatively, you might consider hedging the position.

Do you have most of your wealth in one stock, bond, or other investment?  If so, you are putting yourself in a vulnerable position, and it is up to you to take a hard look at how to protect yourself.  James Cayne may have made enough in his career to weather a billion dollar loss, and Alan Schwartz may have socked away plenty elsewhere, but what about the employees who had most of their life savings in Bear Stearns’ stock?  Next time, they won’t put as many eggs in one basket; take this opportunity to look at your own situation and prevent excessive exposure to one stock or investment.

No matter how much you believe in your company, whether it is the company you own or the company you work for, it is still important to protect your own interests.   Consider spreading your eggs around.

Disclosure:  Suzanna de Baca is President of Private Capital Solutions Group, a financial and investment firm in Des Moines, Iowa.  She is a Registered Representative and Financial Advisor of Park Avenue Securities LLC (PAS), 7 Hanover Square, New York, NY 10004, (888) 600-4667.  Securities products/services and advisory services are offered through PAS, a registered broker/dealer and investment advisor. Private Capital Solutions Group is not an affiliate or subsidiary of PAS.
PAS is a member FINRA, SIPC.

Material discussed is meant for general illustration and/or informational purposes only and it is not to be construed as tax, legal or investment advice. Although the information has been gathered from sources believed reliable, please note that individual situations can vary, therefore the information should be relied upon when coordinated with individual professional advice.