If mutual funds are the fuel-efficient minivans of the investment community, then company stocks are the exotic sports cars.
They’re fast. They’re sexy. And they appeal to buyers that like a little vroom.
Indeed, few other asset classes can match the hidden potential of publicly held stocks.
A well-timed investment in Warren Buffett’s Berkshire Hathaway, for example, could easily have set you up for an early retirement. Its stock price in May 1981 of $520 grew to more than $192,000 in 2014, and would have netted a return on investment in excess of 36,000 percent.
With that opportunity for rocket-powered growth, however, also comes greater risk.
Stocks that go bust
Consider the wide-eyed optimists who bet all their savings on a high tech start-up in 1999, only to see their paper wealth — plus some — evaporate the following year when the dot-com bubble burst. Or the effects on portfolios and housing values following the 2008 financial collapse.
To maintain a balanced portfolio, Shashin Shah, now wealth manager at SGS Wealth Management in Dallas, suggests average investors have no more than 10 percent of their total portfolio allocated to individual stocks.
During their working years, and depending on risk tolerance, investors should be well diversified among stock and bond mutual funds and cash.
Those who wish to invest in individual company shares might consider a portfolio allocation of 10 percent stocks, 80 percent stock funds and 10 percent bond funds and cash, says Shah.
Perils of employer stock
Bear in mind, of course, that company stocks do not present excessive risk to your portfolio unless you are overexposed to a particular sector — or company.
That goes double for those who invest in the stock of their own employer.
Through stock options, employee stock purchase plans and company stock selections in their 401(k)s, many investors hold a disproportionate percentage of their company’s stock in their total asset portfolio, leaving them vulnerable.
Should their employer falter, not only is their financial security at stake, but they’re likely to lose their job at the same time.
It was a lesson learned by thousands of employees of energy trader Enron Corp. More than 60 percent of Enron’s 401(k) retirement funds were invested in the company’s stock.
Thousands of its employees lost their jobs and life savings when Enron shares plunged from more than $80 a share to less than $1 before it filed for bankruptcy in 2001.
If your retirement plan is currently overexposed to your employer’s stock, consider diversifying through your personal investment accounts by adding money to other investments outside of your 401(k) — in your individual investments, IRAs, etc.
Shah also suggests selling a percentage of the stock options you exercise every year, after discussing the tax consequences of such a move with your accountant.
Though individual stocks have their place, investors should be sure their overall portfolio contains an age-appropriate blend of stocks, bonds and mutual funds.
Diversification may not make you an overnight millionaire, but it will enable you to reach your long-term savings goals — not to mention help you sleep at night.