DIVERSITY IN YOUR 401(k)

Neal A. Deutsch, CFP^®

Published in Rivertown Journal, November 2007

Enron… a company that until January, 2002 most of us had never heard of. Yet today, most everybody is familiar with the name and the story.

Back when the news was ablaze with that terrible corporate incident, it was the employees of Enron that we shared our sympathies with. The employee issue at hand was that they were so convinced of the success of the company that many had invested their 401(k) funds solely into the company stock. Once the company collapsed, so did their life savings. Had they diversified their portfolio, thus avoiding the “all the eggs in one basket” theory, they could have avoided this disaster. So what did we learn from their experience? What did YOU learn from their experience?

Here at Chestnut we are great proponents of asset allocation, which is the antidote to the above. Asset allocation is an investment strategy that seeks to reduce investment risk by spreading the portfolio investments over a number of asset classes, usually in excess of 10. The essence of Modern Portfolio Theory, (with no certainty that any investment strategy will be successful) a Nobel Prize award granted to two gentlemen named Markowitz and Sharpe, says that there is a direct connection between risk and reward. However, at some point, there may be more risk than the potential of reward! It takes advantage of the tendency of different asset classes to move in different cycles, technically referred to as correlation, and thus smooth out the ups and downs of the entire portfolio. Company stocks, guaranteed investment contracts, mutual funds, exchange traded funds and money funds are the most widely available options. Depending on the individual need, risk tolerance and plan availability; sector investments such as real estate or gold may be used.

There is no one single asset allocation model to fit every investor, or for every stage of one’s life. The model is determined by many factors, different for each person’s need. Over time, financial markets and an individual’s goals and situation may change. At this time adjustments should be made. In the construction phase of your portfolio, many factors must be considered: time horizon, tax ramifications, liquidity and marketability needs, risk tolerance and others that are imperative in the design of a balance, appropriate portfolio strategy.

If you are an employee of a company that offers a 401(k) plan, we impress upon you how important it is to spread the risk of your investments. While nobody may know of the true stability of your company, the past has showed us that not everything may be as it appears. If you utilize an investment strategy outside of your 401(k) account, you should incorporate your philosophy throughout all of your investing? Spread your risk… sleep at night. HAPPY THANKSGIVING TO ALL!
 

Neal A. Deutsch is a Certified Financial Planner^™, Registered Securities Principal and President of Chestnut Investment Group in Suffern, NY, helping people with financial planning since 1984. Please feel free to call Neal at 845.369.0016 or email him with your questions at neald@chestnutinvestment.com Feel free to visit his website at www.chestnutinvestment.com