Paul Ferraresi

If you take a rubber band in your hand, stretch it to its limits, then, watch it snap … it will hurt your fingers for sure. At the same time I have watched many investors get “stocked up” by owning too much of their company’s stock.

Sure there are many advantages to owning your company stock; many times it can be bought at a discount; the company may match your purchase; and, who knows the company’s inner workings more than you.

A safe rule of thumb is that you should never have any one security make up more than 10 % of your portfolio. I do not care what the incentives are. In years past I had
some clients that worked for Enron. Their portfolios were comprised of 80%, 90 %, and even 100% of their wealth in Enron Stock. I begged them to sell and get that position down to 10%. Most of them I had to fight with just to get them down to a 20% level. When the stock went to “0” fortunes were wiped out; retirement plans drained and families ripped apart. Why did they do such a foolish move? Greed! The stock was exploding and everyone wants a quick fix to make up for their previous lifestyle of not saving and investing.

There are two irrational investment behaviors that develop out of this “non-diversify” mentality.

• Anchoring: Analysts often underreact to new information when revising their forecasts; investors also tend to assume the current prices are about right.
• Overconfidence: Analysts and investors alike can be overly optimistic about past winners and overly pessimistic about past losers. Even when evidence shows that investors cannot beat the market on a systematic basis, they often believe they can.

Here are a few questions to ask yourself if you have “overindulged” in one stock …

• What are your spending needs, now and for the future?
• How would a drop in the value of your largest holding affect your ability to meet short-term needs, educate a child, start a business, and retire comfortably?
• Do you have the time or resources to recover from such an event?
• Do you have enough liquidity to take advantage of the next opportunity when it presents itself?
• What does this stock represent to you?
• What is your short-term and long-term view of the stock?
• Might there be a better way to maximize returns with less risk?

Many people use the excuse that if they sell now the taxes will be huge. Presently, the capital gains tax rate is 15% … the lowest ever in history. Funny, back in 2000 before the tech wreck, when cap taxes were higher I had a lady with a huge position in a tech stock. She did not want to sell for fear that it would move her into a higher bracket and would make her pay
3 % more in taxes. She held fast. The stock lost 90%. She would love to have paid the 3% more in taxes and preserved the other 87%.

Well only shaky stocks go down you say! Look at a few of the Blue Chip stocks and what happened to them.

Follow the discipline of prudent investing or live in regret.