The Risks Of Employer Stock

February 09, 2025

One of the biggest risks lurking in people’s investments is having too much in a current or former employer’s company stock. What’s too much?

Rule of thumb

You should generally have no more than 10-15% of your investment portfolio in any single stock. It’s worth noting that an investment adviser can lose their license for recommending more than that.

More than just a stock when it’s your job

So why is this such a bad idea? What if your company stock is doing really well? Well, remember Enron, anyone? While it’s practically impossible for a well-diversified mutual fund to go to zero, that could easily happen with an individual stock. In that case, you could simultaneously be out of a job and a good bulk of your nest egg.

Now, I’m not saying your company is the next Enron. It could be perfectly managed and still run into trouble. That’s because you never know what effect a new technology, law, or competitor can have, regardless of how good a company it is.

Nor does the company have to go bankrupt to hurt your finances. Too much in an underperforming stock can drag down your overall returns, and even a well-performing stock can plummet in value just before you retire. As volatile as the stock market is as a whole, it’s nothing compared to that of an individual stock.

Why do we over-invest in our own companies?

So why do people have so much in company stock? There are two main reasons. Sometimes, it’s inadvertent and happens because you receive company stock or options as compensation. For example, your employer may use them to match your contributions to a sponsored retirement plan. Other times, it’s because people may feel more comfortable investing in the company they work for and know rather than a more diversified mutual fund they may know little about.

A general guideline is to minimize your ownership of employer stock. After all, the expected return is about the same as stocks as a whole (everyone has an argument about why their particular company will do better, just like every parent thinks their child is above average). Still, as mentioned before, the risks are more significant. That being said, there are some situations where it can make sense to have stock in your company:

When it might make sense to keep more than usual in company stock

1) You have no choice. For example, you may have restricted shares that you’re not allowed to sell. In that case, you may want to see if you can use options to hedge the risk. This can be complicated, so consider consulting with a professional investment adviser.

2) You can purchase employer stock at a discount. If you can get a 10% discount on buying your employer’s stock, that’s like getting an instant 10% return on your money. If so, you might want to take advantage of it but sell the shares as soon as possible and ensure they don’t exceed 10-15% of your portfolio.

3) Selling the stock will cause a considerable tax burden. Don’t hold on to a stock just because you don’t want to pay taxes on the sale, but if you have a particularly large position, you may want to gift it away or sell it over time. If you do the latter, you can use the same hedging strategies as above.

4) You have employer stock in a retirement account. This is a similar tax situation because if you sell the shares, you’ll pay ordinary income tax when you eventually withdraw it. However, if you keep the shares and later transfer them out in kind to a brokerage firm, you can pay a lower capital gains tax on the “net unrealized appreciation.” (You can estimate the tax benefit of doing so here.) In that case, you may want to keep some of the shares, but I’d still limit it to no more than 10-15% of your total portfolio.

5) You have a really good reason to think it’s a particularly good investment. For example, you work at a start-up that could be the proverbial next Google. It may be too small of a company for analysts to cover, so it may genuinely be a yet-to-be-discovered opportunity. In that case, go ahead and get some shares. You may strike it rich. But remember that high potential returns come with high risk so ensure you’ll still be financially okay if things don’t pan out as hoped.

The ups and downs of the stock market typically get all the media and attention. But your greatest investment risk may come from just one stock. So don’t put all your eggs in it.

What Tesla and United Can Teach Us About Investing

May 05, 2017

In another of my “grumpy old man” rants here, I’m absolutely mystified by investors and the car company Tesla. Sure, they make cool cars. Sure, they are selling directly to consumers and bypassing the traditional dealership model. Sure, every time I see one I give it a long look and think “that’s pretty awesome.” But in the midst of all of all of that, I just don’t understand how their stock price can be so high.

Tesla passed General Motors as the #1 US car company recently. Last year, Tesla sold about 76,000 cars. GM sold about 10,000,000. GM made over $9 BILLION in profits last year, while Tesla has had 2 profitable quarters…EVER! It is perhaps due to the “cool factor” that Tesla is now the #1 car company in the U.S. based on market capitalization. (Market capitalization is simply the number of shares outstanding times stock price.)

Clearly, the stock market is rewarding more than just financial results. As someone who has all but stopped using Facebook, never liked Twitter and is not a fan of social media in general, it seems that the stock market is moving away from rewarding the old school “logic and reason” of profitable companies seeing their stock price rise and companies who have yet to hit their stride from a profitability standpoint not getting much traction in the market. There are a lot of future expectations built into stock prices. This makes it hard to be an investor.

Heck, one video was able to move the stock price of United Airlines. This is a company with $9.1 billion in revenue in just the 4^th quarter of 2016 and the stock price moved because of one cell phone video. This age of social media definitely has ripple effects in the investment markets. No one could have predicted in advance that United would have been hit by a wave of negativity after a cellphone video went viral or that an unprofitable car company would be worth more than General Motors.

Picking individual stocks and outperforming the market is HARD! Most professional managers struggle to beat their respective index. If you bought Apple very early on, you’re probably a pretty happy investor. If you bought Enron or MCI WorldCom, probably not so much. All of those companies had spectacular performance at some point in their history, but only one is still in business.

That’s why it’s becoming increasingly more important to diversify your portfolio. Having a mix of stocks – small, mid-sized, large, international, emerging markets – and bonds and cash can help you avoid devastating losses like many investors experienced in 2008. Check out my blog from last week and get to know who you are as an investor and build a low cost, non-emotionally driven portfolio.

Since I started with a grumpy old man rant, I’ll end with an old phrase that we’ve all heard countless times in our lives. Don’t put all your eggs in one basket! In the investment world, it simply makes sense.

Why You Should Love Investing

April 13, 2017

When a lot of people think of financial planning, they think of investing…with dread. It sounds complicated, time consuming, and risky. But for me, investing is actually my favorite part of financial planning. Let me tell you why…

In most areas of life, we generally get what we put in, whether that’s in terms of the price we pay or the amount of time and hard work we expend. In other words, you get what you pay for. However, investing is the one area of life where you get rewarded for being both cheap and lazy.

Let’s start with the first step, which is diversification. As you’ve probably heard, you don’t want to put all your eggs in one basket, but you still have to decide how many of your “eggs” or money to put in each “basket” or asset class: stocks, bonds, cash, and real assets. What makes this confusing is that there’s a ton of conflicting views on this so investment expert Meb Faber decided to compare 9 of the top recommended asset allocation strategies by various other investment experts and see how they performed since the 1970s. What he found is that the difference between the best and the worst performing strategy was only 1.6% and if you removed the worst performing portfolio (which is an outlier since it only has 25% in stocks), the difference was only 1%. When he compared the models of the major financial institutions, he found that the difference was only about half a percent.

However, just because they ended up in similar places doesn’t mean that they performed similarly from year to year. Each of the models had many years in which they outperformed and many in which they under-performed. If you chose a model based on which was the top performing over the previous decade, you would actually have done much worse. Whether you use a one-stop shop asset allocation fund, a robo-advisor, one of the model portfolios listed in one of Faber’s blog posts above, or a financial advisor’s recommendation, which portfolio you pick is less important than that you pick one (to make sure you’re reasonably diversified) and stick with it through thick and thin. (Everyone, even Warren Buffett, has periods of under-performance.)

There’s one other way you can sabotage your returns: costs. It’s been estimated that the average mutual fund costs .9% a year in expenses and 1.44% a year in transaction costs. (This doesn’t even include any loads or commissions you may pay to purchase the fund.) That 2.34% would be enough to turn the best performing strategy into the worst.

It’s not like you’re getting anything for those costs either. In fact, a recent Morningstar study called low fund fees “the most proven predictor of future fund returns.” Warren Buffett has said the same thing. So as you choose which funds to use in your portfolio, look for ones with low fees (called the expense ratio) and low turnover (which leads to lower transaction costs). If index funds are available, they tend to have the lowest costs and hence tend to outperform more expensive actively managed funds over long periods of time.

The moral of the story is that investment success boils down to three simple rules:

Be diversified. Pick a reasonably diversified portfolio. Don’t be a greedy pig (bet on individual stocks) or a fearful chicken (keep all your money in bonds and cash). After all, both pigs and chickens get slaughtered.
Be cheap. Use low cost funds to implement your asset allocation strategy. In this case, you get what you don’t pay for.
Be lazy. Once you have your portfolio, stick with it. Don’t try to time the market or otherwise, mess with it other than to rebalance it periodically back to the original allocation or to switch to lower cost funds as they become available.

Think about it. Where else are you most rewarded for being both cheap and lazy? Now do you love investing? If so, the first step is to save so you have something to invest, but that’s another story…

Should You Be In an Asset Allocation Fund?

February 09, 2017

One of the most common questions we get on the Financial Helpline is how to choose investments in your employer’s retirement plan. Investing can be complex and intimidating so it doesn’t surprise me that people are looking for help with their decision. What does surprise me is how few of them understand and use an option that was created to help simplify their decision.

Depending on your plan, you may have a target date or a target risk fund available to you. Both are “asset allocation funds” that are designed to be fully-diversified “one stop shops.” All you need to do is pick one fund that most closely matches your target retirement date or your risk level. (Target date funds can also be “set it and forget it” because the funds automatically become more conservative as you get closer to the target retirement date.)

If you think of investing as getting you from point A to point B, asset allocation funds are like the commercial jets of investing. They’re much cheaper than a private jet (a financial advisor) and much simpler than piloting your own plane (picking your own investments). That’s why when I first heard about these funds early in my financial career, I assumed they would take over much of the mutual fund industry and even replace the need for a lot of financial advisors. While they have seen a meteoric rise, especially as the default option in retirement plans, they still aren’t utilized as much as I thought they would be. I think there are 3 main myths responsible for this:

1. Putting everything in one asset allocation fund is having all my eggs in one basket. What you don’t see is that an asset allocation fund is actually a basket of baskets. Each fund is composed of several other funds. In fact, one asset allocation fund is usually more diversified then the typical mix of funds that I see people in.

So why not have other funds in addition to it? Isn’t that making your portfolio even more diversified? The problem here is that these funds were professionally designed to hold a certain proportion of investments so adding others will throw the balance off. It’s like adding extra ingredients to a chef-prepared meal. Only do it if you really know what you’re doing (in which case, you probably don’t need an asset allocation fund anyway).

2. I can probably do better on my own. Remember that these funds were put together by professional money managers who’ve been trained in investment management and do this for a living. What’s the chance that you’ll create a better portfolio? One study of 401(k) participants showed that investors who chose their own funds did worse on average than those who just went with a target date fund.

Part of that is due to lack of knowledge. However, a lot is also likely due to the temptation to buy investments that are performing well and then sell them when they eventually underperform, which is a recipe for buying high and selling low. If nothing else, asset allocation funds provide discipline… assuming you don’t trade these funds too of course.

3. Asset allocation funds are always more expensive. You would think that this professional management would come at a steep price. After all, paying for investment management typically costs .5-1% of your portfolio. However, asset allocation funds are generally only slightly more expensive than other funds and if they’re composed of index funds, they can actually cost much less than most actively managed funds. Check the fund’s expense ratio before making assumptions as to their cost.

That all being said, there are reasons not to use an asset allocation fund. You may not have one available in your plan or the one you have may be too expensive. Sophisticated investors or those with an advisor may want to create a more personalized portfolio that better matches their risk level or complements outside investments to maximize tax-efficiency. But if those situations don’t apply to you, consider an asset allocation fund. Flying commercial may not be a perfect experience, but it’s better than the alternatives for most people.

Financial Wisdom From My Grumpy Old Man Side

January 13, 2017

Sometimes I like to have some fun and adopt a “grumpy old man” persona for a bit just to keep everyone around me on their toes. My kids have started to say “OK, Grandpa…” when I get into my grumpy old man role. Sentences starting with “back in my day” or “when I was your age” or containing the words “poppycock”, “shenanigans”, and “new-fangled” are standard when I’m talking as that character.

The funny thing I noticed this morning as I was playing this part is that a lot of what I say as that person is absolutely true. The principles are valid and while I may be joking around and having some fun, there is some real timeless stuff that I wish more people in today’s world would implement as a part of their lifestyle. Here are some of the top nuggets of wisdom from my grumpy old man character:

Back in my day, if you didn’t have the cash, you didn’t buy it. I have seen more people get themselves in trouble financially through excessive use of credit cards than for any other reason. As credit card debt mounts, so do minimum payments as well as stress. I can’t count the number of divorces and therapist visits that people have attributed to credit card debt.

When I was your age, I always saved some money for a rainy day. Having an emergency fund, whether it’s a “starter emergency fund” of $1,000 – $2,500 or a 6-9 month cash cushion, is a great way to ensure that your financial life won’t get blown to smithereens in the event of a job loss, injury or illness. An emergency fund is the #1 barrier to unwanted debt.

What’s with all the shenanigans of picking all these stocks? Don’t put all your eggs in one basket. This is a time honored principle that the folks who worked at Enron or MCI WorldCom wish they had reinforced by senior management. The best way to “get rich” in the stock market is to find the next Apple or Google and put all of your money in that stock, but finding THAT stock is a lot tougher than it sounds and you’re more likely to find one that ends up going nowhere. So spreading your risk out among many different asset classes is a great way to participate in the whole stock and bond markets rather than concentrating your risk (and potential reward) in one area.

Who needs all these new-fangled gadgets that you spend so much money on? Another principle that works every time it’s tried is spending less than you bring home. So many people I talk to are very excited about the next iPhone that is coming out or 4k televisions or new and cool technologies that can make people say “wow.” Those things are fun and cool, but they can improve your quality of life only very slightly and they are usually pretty pricey.

By holding off on those purchases, along with driving lower priced cars and living in reasonably priced housing (the things Americans tend to vastly over-spend on), there will be plenty of room for savings and taking on debt will be a thing of the past. Think about the last “cool” purchase you made and how quickly the cool factor evaporated. Wouldn’t it be cooler to save that money and be able to retire a year or 5 earlier?

Part of the reason that I can act like my grandfather and use some of the phrases I heard as a kid is that the wisdom in those phrases has withstood the test of time. Just like 2+2=4 was true when I was in elementary school and is still true today (although the way it’s taught is different now), these little financial nuggets were true then, they are now, and they will be when my kids are grandparents. (This BETTER be in a long long time!)

Why I’m Investing 100% of My 401(k) into One Stock Fund

December 15, 2016

Like many companies, Financial Finesse recently changed the fund line-up in our 401(k). As part of the new offering, we now have target retirement date funds that are fully-diversified “one stop shops” that automatically become more conservative as you get closer to the target retirement date. But rather than this more diversified approach, I’m choosing to put 100% of my 401(k) into an S&P 500 index fund. While this strategy is certainly not for everyone, here’s why I decided it makes sense for me:

It complements my investments outside the 401(k). If you have retirement investments outside your employer’s retirement plan, you might want to look at all of your retirement accounts as one big portfolio. In my case, the bulk of my outside retirement investments will be in real estate and microcap and international value stocks. Since I’m a very aggressive investor with my retirement portfolio, I have no interest in bonds or stable value. Therefore, domestic large cap stocks can best diversify my overall portfolio without sacrificing much in expected returns.

Index funds tend to outperform actively managed funds. It’s also the only index fund offered in the new plan. This is an important point because studies have shown that index funds tend to do better than the vast majority of actively managed funds in the long run, primarily because of their low fees and trading costs. While value stocks tend to outperform in the long run and growth stocks would better complement my already value-heavy portfolio, both advantages can be wiped out by the higher costs of active management.

Warren Buffett recommends it. Arguably the greatest investor alive today has recommended index funds to both Lebron James and average Americans. He’s also put his money where his mouth is, instructing his trust to invest 90% of his estate in an S&P 500 index fund for his wife when he passes away and betting a $1 million to charity that a simple S&P 500 index fund would outperform a selected group of top hedge fund over 10 years. (It’s year 9 and he’s way ahead so far.) If it’s good enough for Buffett, it should be good enough for me.

Of course, this certainly doesn’t mean everyone should put 100% of their employer’s retirement plan in an S&P 500 index fund. If you don’t have much outside your plan, your portfolio may not be diversified enough without international and small cap stocks. Unless you’re also a very aggressive investor, you’ll probably want some bonds and cash as well to reduce the portfolio’s risk. This is why most people are probably better off investing in a more diversified portfolio like the target date retirement funds we have now. As always, you’ll want to make sure you’re making an informed decision that’s best for you.

Is Too Much of a Good Thing a Bad Thing?

December 02, 2016

During some recent conversations with employees of a publicly traded company, the topic of company stock was very popular. This company’s stock price has tripled (300% gain, point to point) in the last 5 years, while the Dow Jones Industrial Average has increased over 50% (from ~12,000 to ~19,000). What that has done to employee 401(k)s, for those who contribute to company stock inside the plan, is ratchet up the percentage of company stock beyond the 20% limitation that the firm’s policies allow. For those who have participated in the employee stock purchase plan (ESPP) or who receive some form of equity compensation (restricted stock, stock options), their company stock holdings could even be higher. The question around their building during these conversations was “do I have too much company stock?”

My answer to that question was almost always “it depends!” Most financial planners will recommend that no more than 10-15% of one’s portfolio should be in employer stock. Employees at Apple or Google would disagree with that, while employees of MCI WorldCom and Enron think that is probably 10-15% too much. While that rule of thumb is out there, it is often misconstrued.

I spoke with one employee recently who had 40% of her 401(k) in employer stock and she was concerned because her financial advisor told her that was far too much to have. When we broadened the scope, from just her 401(k) to her total portfolio, we found that only 5% of her total wealth was in employer stock. She had most of her money in CDs at her local bank and in a portfolio of bonds with her financial advisor. Her employer stock was almost her only growth asset. We did talk about more broadly diversifying her portfolio and about allowing her financial advisor to know that she had the CDs at the bank too so that his recommendations could be with the full knowledge of her situation.

The lesson: When looking at employer stock, look at the whole picture not just one account.

I spoke with another employee who had 15.1% of employer stock in his 401(k) and his plan provider had a big red warning sign on his 401(k) one day. If the stock price fell and the stock became 14.9% of his plan, the red warning sign would go away the next day. He was right on the edge, as he viewed it – and as his 401(k) plan provider viewed it.

He wasn’t too concerned because he is highly optimistic about the company’s future. During our conversation, he convinced me that he totally understood the risks associated with having one stock be too big a portion of a portfolio. When I asked a follow up question about equity compensation and the ESPP, he told me that an amount equal to his 401(k) balance was sitting in company stock through the ESPP and restricted stock grants.

So 65% of his investable asset base was in company stock, and this company is going through a merger that may be wonderful or dreadful for the company stock price. Upon realizing that, I asked “Are you more concerned about your stock price doubling right after you scale back your holdings or the stock price falling by half if you don’t scale back your level of holdings?” He was far more concerned about the stock price falling if the merger didn’t get approved or if the overall stock market tanks after 8 years of increases so he opted to scale back some of his holdings by selling ESPP stock and paying off his mortgage.

The lesson: Be aware of where the overall markets are, what your risks are and the full scope of your holdings.

To answer the question of “How much employer stock is too much” requires a fairly thorough understanding of your financial life and goals, the economy, current events/news regarding the company and your willingness to accept large losses in an attempt to make large gains. I’m certain there are people at Google who wish they could buy nothing but Google stock, and I know for sure that there are people who once worked at Enron who wish they had never owned a single share of Enron stock. Each person is different, but understanding your specific situation and the risks and rewards of your employer stock can help you come to the right answer.

Are You Prepared For the Unexpected?

November 17, 2016

If you’re like me, you may have been quite surprised (whether in a good or bad way) by the election results last week. The fact is that things don’t always go as we expect and sometimes life throws us curve balls. For example, I recently had a trip in which my first flight was delayed, then the Wi-Fi that I had been planning to use to get some work done on my second flight wasn’t working (here’s a different perspective on this), and then I found out my luggage hadn’t made it to my final destination.

Fortunately, I had everything I needed to finish my work (including writing this blog post) on me and the rest was delivered to my hotel by the next morning. The key is to be able to roll with the punches and that’s a lot easier when we’re prepared. The same is true in our financial lives. Here are some preparations for life’s financial curve balls:

Insurance

Knowing how my travel day had gone, I opted for the more complete supplemental liability insurance for my rental car. I knew the odds of an at-fault accident were low, but it could happen and being carless, I have no other insurance. That means I could be personally liable for thousands or even hundreds of thousands of dollars in damages in the event of an accident.

Insurance is for those unlikely but disastrous events that could leave us financially debilitated. (If the event is likely, the insurance wouldn’t make financial sense for the insurance company and if the event wouldn’t be disastrous, the insurance wouldn’t make financial sense for you.) Make sure you have enough property and casualty insurance to replace your valuables and to cover your assets in case you’re held liable for damages. That may mean having an umbrella liability policy if the limits on your auto and homeowners insurance are too low. Don’t forget health, disability, life, and perhaps long term care insurance too.

Emergency Fund

If insurance covers the unlikely events, the emergency fund is also for all the things we know will happen but can’t predict when. Your home and car will need repairs. You’ll have out-of-pocket medical expenses. You’ll probably be in between jobs at some point. If you don’t have adequate emergency savings (ideally enough savings and other supplies to get you through at least 3-6 months), you may end up having to borrow the money at astronomical interest rates or even worse, losing your home or car if you can’t make the payments.

Advance Health Care Directive and Durable Power of Attorney

These documents specify your wishes or delegate someone to make those decisions for you in case you’re unable to. You can get advance health care directives drafted and stored for free at My Directives. A durable power of attorney is relatively inexpensive or you may be able to get it for free as an employee benefit.

Investment Diversification

Just like things don’t always go as we expect in our personal lives, the same is true for the overall economy as well. That’s why we diversify our investments. Have at least 30 different stocks in various sectors (if you have a mutual fund, you probably already have this) with no more than 10-15% of your portfolio in any one stock (especially your employer’s). You may want to include bonds, cash, and even alternative asset classes in your portfolio like real estate and commodities as well. Even the most diversified portfolio can lose value but by holding for the long term (at least 3-5 years), you also diversify by time and so the good years can make up for the bad ones.

Just because most of the political or financial experts predict an outcome doesn’t mean they’ll always be right. Life has a way of making fools of us all. When it does, you’ll want to be prepared.

How to Protect Your 401(k) After Brexit

June 27, 2016

Will the “Brexit” affect your 401(k)? Global stock markets fell on the news that voters in Great Britain voted narrowly to leave the European Union. Investors don’t like uncertainty, and there will be plenty of that during the next few years as Great Britain and the E.U. sort out the terms of their divorce. Employees are worried, calling our Financial Helpline to ask whether they should react now to protect their retirement savings. Here are some questions to ask to determine what action, if any, is needed:

Does my overall portfolio match my risk tolerance?

Does all the news about the Brexit have you compulsively checking your portfolio during the day? Are you tempted to throw in the towel and put everything in the lowest risk investment possible? If that’s the case, then maybe it would be a good time to double check your investment risk tolerance.

Try downloading our risk tolerance and asset allocation worksheet, a questionnaire which help you determine your risk tolerance and time horizon to get an idea of what investment mix is best for you. Compare the results to your current portfolio mix. If they line up, you don’t need to re-balance. If there is a big discrepancy, you may want to make some changes. This blog post from my colleague Scott Spann, PhD, CFP® offers some guidance on choosing the right investments in your 401(k).

Keep in mind that investing in stocks and bonds always involves some financial risk. Bad days or even years in the stock market are completely normal. However the risk of not investing in stocks and bonds means that the money you save will lose purchasing power over long periods due to inflation (the rising cost of living).

Is my stock portfolio well-diversified by sector?

My fellow planner Cyrus Purnell, CFP® noted that, “Even if you have the right mix of stocks, bonds and cash, it is worth checking to see if your holdings are sector heavy. The Brexit shock is beating up some sectors more than others. If you have stock funds that are focused on financials (banks, brokerage firms and investment managers), you may see more than the average downturn.” International funds focused on Europe are also likely to have some hiccups as Brexit gets sorted out. “If you are running into high concentrations of sectors, consider indexing,” he added.

When is the last time I ran a retirement calculator?

The reason you’re investing in your 401(k) is to build a nest egg for retirement. Measure your success against whether or not you are on track to achieve your retirement goals, not from the highest balance on your 401(k) statement. Now is a great time to run an updated retirement calculator to see if you are on track, given your savings and reasonable projections for your rate of return and inflation. You can use our Retirement Estimator for a basic check in to see if you are on track. You can also use the calculator to model different scenarios using different rates of return to see what happens.

Be realistic in your estimates: recent research from the McKinsey Global Institute suggests investors lower their expectations for average annual US stock returns to 4 to 6.5%. It’s better to use a conservative expected rate of return. If you’re wrong about it, you’ll be happily surprised, but if you’re right, you’ll be adequately prepared.

Do you have a personal finance question you’d like answered on the Monday blog? Please email me at [email protected]. You can also follow me on Twitter at @cynthiameyer_FF

How to Build Your Own “Hedge Fund”

June 02, 2016

Hedge funds have long been considered the sexiest investments. Part of it is that they’re exclusive, legally limited to “accredited investors” and financially limited to those who can afford their high fees (typically a management fee of 1-2% plus about 20% of the fund’s performance). They’re also the largely unregulated bad boy of the financially world, which allows them to use complex investments and strategies to try to outperform or hedge against the market for higher returns and/or lower risk.

I’ve always been skeptical of hedge funds though, so I was interested to read an article titled “Hedging on the Case Against Hedge Funds.” It defends hedge funds from a lot of criticism they’ve been getting lately for charging those high fees while producing disappointing performance numbers. (For example, Warren Buffett is on track to win a $1 million bet that a simple S&P 500 index fund would beat a group of top hedge funds over 10 years.)

The article makes the case that hedge funds can’t be expected to always outperform the stock market when stocks are doing particularly well. After all, many hedge funds are designed to “hedge” against the market so while they may not do as well when stocks are up, they should do better when stocks are down. But the article still ends up arguing that hedge fund fees are too high and that they perform too similarly to the stock market rather than acting as a true hedge. Fortunately, there are ways to get that type of hedging without paying such high fees.

For example, one strategy is the “permanent portfolio,” described by the late investment author Harry Browne in his book Fail Safe Investing. The concept is to divide your money with 25% each to stocks, long term government bonds, gold, and cash. The idea is that since stocks tend to do best during prosperity, long term government bonds during deflationary recessions, gold during periods of rising inflation (which can be bad for both stocks and bonds), and cash during “tight money” recessions when all the others may lose value, part of the portfolio should always be doing okay no matter what the economy is doing. By periodically re-balancing, you would sell some of the best performing investments while they’re priced relatively high and buy more of the worst performing ones while they’re priced relatively low. This can reduce your risk and increase your returns.

The numbers speak for themselves. From the year the book was published in 1999 to 2015, the permanent portfolio earned a 6.13% compound annualized return compared to 5.76% for a traditional 60/40 stock/bond allocation and 4.89% for the S&P 500. More impressively, the permanent portfolio’s worst year was a loss of only -3% vs. -20% for the traditional portfolio and -37% for the S&P 500.

Unlike the high fees charged by hedge funds and other active managers, the portfolio can also be created with a mix of low cost index funds. The value of this shouldn’t be overlooked. A study comparing the model portfolio allocations of various financial institutions found that the difference in returns between the best performing portfolio (9.72%) and the worst (9.19%) from 1973-2015 was about half a percentage point. Since the average active stock fund charges .86% in expenses and the average stock index fund charges .11%, going from index to active funds could have turned the best performing portfolio allocation into the worst! (And no, active funds don’t generally make up for their higher fees with higher performance.)

So does this mean you should invest in the permanent portfolio? Not necessarily. You just need to make sure your portfolio is broadly diversified beyond the stock market (including more conservative investments like government bonds and cash and real assets like gold or real estate) and has low costs. If you do that, there’s a good chance you’ll actually outperform most hedge funds. Your portfolio may not be as sexy but you can take it home to mom and dad.

Don’t Let Financial Advisor Speak Confuse You

April 29, 2016

“You have to get off the plane. I have the feeling that something is wrong with the left phalange”… “Oh my GOD…there’s NO phalange!”

That was Phoebe from Friends talking about her fear right before a plane took off. She had no idea what the parts of the plane were called and picked a fun word to say. Having broken a few phalanges in my life, I learned that word was a fun one in my youth. But what’s not so fun is having a professional, in any profession, talk to you in words you may not fully understand. When I’ve busted up parts of my body, I’ve asked the orthopedic surgeon to “dumb it down” a bit for me and explain the surgery in clear and simple terms.

When it’s your health or your money at stake, don’t be afraid to ask for an explanation of terms in real English, not industry jargon, so that you can make informed decisions. Recently, I had my kids (17 & 14) listen to a webcast about the “basics of investing” given by a local financial advisor. Here are some terms that the advisor dropped during the webcast that he thought everyone on the webcast would understand, but instead they had him lose kids who hear their dad and his coworkers talk about financial planning on a fairly regular basis:

Asset Allocation: This advisor must have used this term about 20 times and spoke of it as though everyone in the room would understand it. A few people did, but at one point a participant asked him what that meant and my kids said “Thank you!” very quietly. They have gone to my office and heard my end of work-related phone calls since birth, but they were confused by this one. The advisor believed it was universally understood. Asset allocation is simply how your money is divided between different types of investments like stocks, bonds, cash, real estate, etc. .

Diversification: This one goes hand-in-hand with asset allocation. Diversification simply means not having your eggs all in one basket. What diversification ISN’T is owning 6 different CDs at 6 different banks or 5 different S&P 500 (is that jargon, too?) index funds.

ROI: The advisor talked a few times about meeting with your advisor (who he hoped would be him!) to review your ROI frequently. My kids didn’t realize it was a 3 letter acronym. One thought it was something like “Ahroweye” and they had never encountered that word before. ROI, for those who aren’t sure, is “return on investment” or in English – “how much money did I make?”

Fiduciary: The advisor mentioned that he always acts as a fiduciary for his clients. That made me smile, but I know what that means. He talked about being a fiduciary about a dozen times, but never took it a step further to explain what that meant. After the formal presentation, one of the participants asked what that meant because he had said it so often. Sadly, most of the participants dropped off before he explained that a fiduciary MUST legally put his clients’ interests first, rather than his own.

It’s sad that this concept has a term that requires it to be done. Most clients of financial advisors would be shocked to know that the advisor isn’t required to put their interests first in most client/advisor relationships. That’s the way the world should work, but that’s not the way it actually works…unless the advisor is acting as a fiduciary. This is a very important term that the advisor simply assumed that the audience would understand.

There are a whole lot more terms that I hear advisors use with regularity that the general public wouldn’t understand initially. I will throw some more of them out there in a future blog post. Whether you’re talking about phalanges, uvulas, or hedge funds, the key is to make sure that the professional having this conversation with you slows down and makes sure you understand and don’t allow yourself to say “yes” to a surgery or an investment until you are completely confident that you have all the information you need to make the best decision possible.

Don’t Make These Common Investing Mistakes With Your 401(k)

March 17, 2016

In our CEO’s new book, What Your Financial Advisor Isn’t Telling You: 10 Essential Truths You Need to Know About Your Money, Liz Davidson writes about how the best place to invest your money is often where you made that money: your workplace. While most people generally understand the value of contributing to their retirement plan, there’s a lot of confusion about how they should choose investments. Here are the biggest mistakes I see people making: Continue reading “Don’t Make These Common Investing Mistakes With Your 401(k)”

3 Ways to Make Market Volatility Work For You

February 15, 2016

Does the recent market volatility make you afraid to look at your 401(k) statement? Maybe it’s time to think about adopting a portfolio rebalancing strategy. Rebalancing is the process of periodically selling or buying investments in your portfolio in order to maintain your target mix of investments over time. It helps you keep the level of risk in your portfolio stable by taking some profits from those funds that are now taking up more space in your portfolio than originally intended – usually because they grew in value – and buying more of the funds that are now taking up less space than you intended, possibly because they fell in value. Since stocks, bonds and other investments tend to move up and down at different times, implementing a regular rebalancing strategy with a diversified portfolio mix helps you “buy low, sell high” over the long haul. Continue reading “3 Ways to Make Market Volatility Work For You”

What Makes A Good Mutual Fund?

June 25, 2015

That’s a common question I get in our investing workshops. Most people instinctively look at performance. After all, that’s how we typically measure ability and try to predict future performance in most areas but investing is different. Continue reading “What Makes A Good Mutual Fund?”

How to Invest While Getting a Tan

June 10, 2015

June signifies summer, a time when millions of Americans flock to frolic in the sand and soak up some sun. If only investing were as easy as a day at the beach…or is it? It can be if you follow these simple guidelines: Continue reading “How to Invest While Getting a Tan”

Three Investment Terms You Should Know

April 22, 2015

Have you ever noticed how different words mean different things to different people? The other day I was talking with a helpline caller who was looking for a way to invest their retirement funds such that they couldn’t lose money and could draw an income from it in the future. When I mentioned the word “annuity,” they immediately had a negative reaction as they were lead to believe all annuities were bad, which seemed ironic considering that’s exactly what they just described they were looking for. When it comes to investment terminology, not understanding the meaning of a word can be a financial mistake. Here are three investment terms that are frequently used but often misunderstood: Continue reading “Three Investment Terms You Should Know”

All You Need To Know About Investing In 3 Simple Steps

April 16, 2015

Whenever I talk to people about investing, I find that most people fall into one of two groups. One group feels that investing is too complicated for them so they want to hire a professional to manage their money for them. The other group is make up of active investors who try to time the market with statements like “I think the market is too high to get in right now” or “I’m going to wait for prices to come down before I buy” and/or pick stocks or actively managed funds that they think will outperform the market. The problem is that there’s no evidence that market timing or even actively picking stocks really works (unless monkeys or cats are doing the picking). If the vast majority of professional money managers continue to underperform the market with these methods, do you really think you can in your spare time? Continue reading “All You Need To Know About Investing In 3 Simple Steps”

Are You Choosing the Right Investments in Your 401(k) Plan?

June 30, 2014

It can be hard to figure out if the investment selections within your retirement plan investments are a good fit for your personal goals. The concept of diversification is usually represented by the phrase “don’t put all your eggs in one basket.” It makes perfect sense but how do you know which baskets are the best fit and how much do you put in each basket? Continue reading “Are You Choosing the Right Investments in Your 401(k) Plan?”

Lessons from the World Cup About Diversification

June 16, 2014

The 2014 World Cup started with a bang on Thursday with the host nation Brazil beating Croatia in a somewhat less than convincing fashion. National pride and hope is growing in the host nation of Brazil and across the globe with 32 nations vying for the World Cup trophy. Like many American soccer fans, I’ve enjoyed watching other countries play the past few days… but now the real fun, stress, and patriotism begins. The United States takes on Ghana today. Continue reading “Lessons from the World Cup About Diversification”

How Buying Clothing is Like Investing

May 29, 2014

Last week, I wrote about how I was able to buy a new set of clothes without breaking the bank. In the process, I realized something else too. It turns out that putting together a wardrobe is a very similar to putting together an investment portfolio. Here are some lessons I learned and how they apply to investing: Continue reading “How Buying Clothing is Like Investing”