Diversification of Portfolios

Making an Investments
I agree with this statement. It is the decision of the employee to decide where to place their finances and trust. In regards to the Enron scenario, considering there were many options for the employees to choose from, they could have taken their investment and placed it elsewhere. Alternatives for investment options include banks in which the individual trust. For instance, when an individual is selecting a bank to place their savings or paycheck, they are likely to select the bank that they trust most. The individual makes their investment decision based on the banks track record, customer support, reliability, references, etc. In the end, if the individual were to make the wrong decision by selecting a bank, which unexpectedly closed for business, the individual could partially blame himself or herself for not researching the firm enough. It is the unfortunate reality that is often a factor in risk taking and investment decision making. It is the responsibility of the investor to research the risk tolerance of the organization that it invests in. It is not the responsibility of the organization for the investor’s bad investment. Although the organization should have morals and ethics, that cannot be guaranteed. Consequently, it becomes the responsibility of the individual or investor to do their research.

Stock Diversification
Employees and investors should not rely solely on stock options for items such as retirement plans. Often, employees over-invest into company’s like Enron because of dramatic share increases. While it may seem unlikely that a company of such magnitude could fail, stocks have the ability to plunge in value and investors can lose all of their investment in the process. It would have been more beneficial and wise had the employees diversified their stocks by only placing some funds in Enron stocks, and the rest elsewhere. Stock diversification creates less risk and minimizes the effect of a stock crash like in the case of Enron. Of the Enron stock, 89% belonged to employees and investors who chose to put their investment there. The individuals and investors had multiple options of moving their funds to a more reliable and trustworthy source or keeping it in a home safe, storage unit, or elsewhere. The fall of Enron was an unfortunate risk that the employees took and one that investors make often.

There are many excellent reasons why diversifying investments is the better decision. However, there are also many reasons as to why employees choose not to diversify. In regards to employees at Enron, they likely felt safe and confident that they were making the best decision. The company was doing very well. Sudden and unforeseen failure seemed nearly impossible based on the company’s current value at the time before the crash. The reason employers invest money into an employers stock is viewed as a psychological reason. Employees underestimate the risk associated with company stocks considering they are familiar with the company and its direction.

According to a survey by The John Hancock Financial Services Defined Contribution Plan, consumers often rate employer stocks less risky than an equity mutual fund. In addition, employees may invest into company stocks because of their loyalty to the company along with management and peer encouragement. For instance, at Enron, in 2001, CEO Ken Lay twice advised employees to purchase company stocks, promoting the bargain they would receive if they did. Within that same timeframe, Lay himself sold twenty million dollars worth of shares without disclosing to the employees. It is up to the employee to decide where to place their trust and finances. The Enron CEO situation is a clear example that employees should have been paying attention to the status of their investments and its leaders.

Concentrated investments are riskier than diversified portfolios, particularly in employee situations. The results can be devastating for employees who invest into company stocks that fail. Not only does the individual lose their job in these types of situation, but they also lose their savings and retirements. Diversifying investments protects the investor from excessive financial exposure. However, diversification causes missed opportunities of major profit gains.

Along with advantages to diversifying investments, there are also reasons as to why individuals and investors select only one investment option. By not diversifying, the investor chooses one or a few areas to invest within where they feel confident and satisfied. Often, selecting a single investment allows individuals to focus their attention on higher profit margin investments. For instance, by diversifying a $50,000 investment into 100 holdings, the investor can only expect small returns on the positive holdings. Although diversifying stocks prevent a large loss, choosing to diversify stocks will miss large opportunities of a gain.