Thursday, April 10, 2014

Investment Diversification

One of the basic axioms of investing is portfolio diversification. Simply put, an investor should not “put all eggs in one basket.” Prudent investing includes allocating your investment dollars among asset classes (stocks, bonds, cash, etc.) and different investment styles (large cap value, small cap growth, international, etc.). That allocation should be done in accordance with the investor’s goals and objectives; generally the higher the allocation to stocks, the greater risk in the portfolio. One of the factors that may not be considered is the investor’s job or employment. What do we mean?

First, one of the greatest destroyers of wealth is the necessity to liquidate investments in a down market to meet necessary living expenses. Therefore, anyone in a tenuous job situation should ensure an adequate cash/fixed income reserve to cover living expenses in the event of job loss. This reserve may mean a lower exposure to stocks. A corollary to this job situation is the entrepreneur or small business owner who may face significant new challenges in view of tax changes and health care requirements under the Affordable Health Care Act. Risk in the business environment might indicate more stable fixed income investments in the investment portfolio would be advisable.

Second, and a more likely scenario, is a concentration of investments and employment. Does an employee have most (all?) of their 401(k) investments in company stock? Some dangers exemplified here are wealth tied to the company (think Enron) or industry. Frequently investors will have investments associated with their profession/industry—perfectly logical given their understanding of the industry. However, such concentrations can pose special risks. A downturn in the industry can potentially affect both employment and ancillary investments. The downturn in the housing industry resulted in declines in home building employment and associated businesses that supplied the industry.

At Paragon Financial Advisors, we try to assist our clients in doing a through risk analysis. That risk analysis includes two components: 1) the investor’s risk tolerance, and 2) risk exposure to things of which the investor may not be aware such as the situations discussed above. Please give us a call if we can assist you.   Paragon Financial Advisors is a fee-only registered investment advisory company located in College Station, Texas. We offer financial planning and investment management.




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