Managing portfolio risk

If you are a business owner or work for a public corporation, a significant amount of your net worth may be in the form of your ownership in the company. You may be taking on significantly more investment risk than you have intended. Let’s look at some ways to minimize the risk associated with this company ownership.

If a significant amount of your family’s net worth is the value of the company that you own or stocks and stock options in a public company for whom you work, it is important to include these values in the equity portion of your investment portfolios asset allocation. Often, business owners and corporate executives do not remember that the value of their ownership in the company for whom they work is also an equity investment.

As we have often stated, portfolio asset allocation, in which you determine the percentage of total assets to be allocated between stocks, bonds, alternatives, and cash is a critical activity required to maximize your investment returns. To properly allocate one’s assets, the value of your ownership in the company for whom you work must also be included with the equity portion of your portfolio allocation.

As an example, let’s assume that you are a fairly aggressive investor with a desired portfolio allocation of eighty percent equities and twenty percent fixed-income and cash investments. Let’s further assume that your current net worth is one million dollars with $500,000 being in the value in your business and $500,000 in an investment portfolio. In this example, you should have no more than $300,000 of your investable portfolio in equity investments, since you already have $500,000 of your portfolio invested in the equity (stock) value of your small business.

If you are a more “conservative” investor, and wish to have a 60 percent equities and 40 percent in fixed-income and cash positions, only $100,000 of your $500,000 investable portfolio should be put into stocks. While this is only 20 percent of your investment portfolio, when combined with your company ownership, your total equity investment is 60 percent.

It is also important to consider size and the market space of your company. A well diversified portfolio has equities in Small Cap, Mid Cap, and Large Cap companies. If you own a small company, the equity purchases in your investment portfolio should be in Large Caps and Mid Cap firms. However, if you work for a large corporation and have a significant amount of your net worth in that company’s stock and/or stock options, your investible portfolio should have a larger percentage of equity holdings in Small Cap and Mid Cap firms.

If your company ownership is in the high-tech industry, focus your investment portfolio on stocks of companies that are in other industries. This approach helps maintain a well-diversified portfolio, one that is not overly dominated by any industry. Having exposure to multiple industries helps to minimize the risk that all of your stocks will decline together, since companies in the same industry often have declining stock prices at the same time.

If you work for a publicly traded company, it is important to remember that both the stock that you own and your paycheck are dependent upon the continuing success of your firm. With so much at stake with one company, it is usually best to have no more than 10% of your liquid net worth invested in the stock of the company for whom you work.

Risk diversification is an important aspect of safely accumulating the resources required for an abundant retirement. Often, small business owner’s and senior executives forget that the value of their ownership in the company for whom they work is an equity investment that should be included in their investment portfolio. By honoring this important fact, your total portfolio will be better diversified.

For many years it has been well understood that a well diversified portfolio is critical to an investor’s long term success. By including your ownership in the company in your equity allocation, you will lower your long-term investment risk and help assure your pathway to an abundant retirement.
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Wayne Farlow is the founder of Financial Abundance, LLC, providing fee-only financial planning, asset management and retirement planning services. He is the author of “Financial Abundance Guide,” available at www.finabguide.com . He can be reached by email at [email protected] or at 303-554-0309.