So far, we have considered several risk factors as if they were independent of each other and could be managed discreetly. Unfortunately, risk is much more complicated than all that. Risk factors tend to be correlated, and there are sometimes unexpected interactions. There are also psychological issues to consider. Do you have a grasp on how much portfolio risk you can consistently stomach?
If you are like me, you sometimes fall into the trap of thinking of real life as one “plane” and market happenings as being something that transpires in Marketland, far removed from our daily reality. This is a very risky trap to fall into, and it can have devastating consequences.
When in Marketland, we tend to be consumed by thoughts of market risk. Always keep in mind that there are myriad things happening in your life alongside your investments. What happens outside your portfolio can affect how you react to your portfolio, and even affect the value of it. If equity markets are down for a long time, it typically means that the economy is slow or slowing. This can mean that consumer confidence is low, and perhaps your job at risk.
I am sure we could fill this book with such examples of how factors that are technically outside of the market really have an impact on our portfolio, either objectively or subjectively. The bottom line is that these outside influences create stresses in your life that may affect the way you employ your well-thought-out strategy. Another example provides an important cautionary tale.
Many companies give stock options to employees as incentives, and all too frequently, employees are overzealous about the company’s prospects. These folks tend to make the error of failing to diversify. From an investment perspective, having your investments supersaturated in a single stock, rather than in a diversified portfolio, exposes you to excess volatility, based on that one company. Moreover, when that firm is also your employer, your economic well-being is already highly concentrated in the fortunes of that business in the form of your job, your paycheck, and your benefits, and possibly even your retirement savings.
Second, history is littered with formerly high-flying companies that later became insolvent. When Enron declared bankruptcy in 1999, approximately $1 billion in employee retirement savings evaporated into thin air. Lehman Brothers employees experienced similar fortunes in 2008, as did Radio Shack workers in 2015. Consider, too, that income from your employer pays your nondiscretionary monthly bills and your health insurance. Should your company’s prospects take a turn for the worse, you could find yourself out of a job, with no health insurance and a dwindling nest egg.
Stock from an equity plan is usually a large component of an employee’s annual compensation, so it is easy for your portfolio to become overly concentrated in your employer’s stock. You need to take a step back, consider how these benefits fit into your long-term financial objectives, such as college savings, retirement, or a vacation home, and develop a plan to diversify accordingly.
[ Back | Contents | Next ]
Last Updated: 6/25/2018
Products from Amazon.com
Price: $22.91Was: $24.95