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Buying company stock
How much of my portfolio should be invested in the stock of the company I work for?
September 16, 2005: 10:49 AM EDT
By Walter Updegrave, CNN/Money contributing columnist

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NEW YORK (CNN/Money) - I work for a major financial services firm that allows us to buy company stock once a quarter at a 15 percent discount. I want to take full advantage of the discount, but I'm not sure what percentage of my portfolio should be invested in this one stock. Considering the discount, what do you recommend?

-- Eric Rocket, Tampa, Florida

Hey, I'm all for taking advantage of discounts. And assuming that, after doing some basic research you find the company you work for has good future prospects and isn't some sort of an economic basket case making this offer to employees to help shore up a sagging stock price (think Enron), it probably makes sense to take advantage of the offer.

Beware of loading the eggs into one basket

But I'd advise you to go easy and focus not so much on the 15 percent discount, but the effect of putting a large share of your money in one stock.

Although there's no single percentage that's appropriate for all situations, I'd say you probably should limit your employer's stock to about 10 percent of your overall investment portfolio. And even if you're incredibly optimistic about your company's future performance, I still wouldn't go to more than 20 percent tops -- and that's a level I'd be very wary of.

Those percentages, by the way, include any company stock you may already hold within a 401(k) or other company savings plan, plus the value of any company stock options you may have.

In fact, if, like some company executives, you have a large portion of your net worth tied up in company stock options, then you should probably pass altogether on the discounted stock offer since you've already got so much of your economic future riding on this one company.

Specific stock risk

Why am I so cautious about cashing in on this display of corporate largesse? The main reason is that any time you make a large bet on a singe stock -- whether your employer's or that of any other company -- you are increasing your exposure to what professional investors call "specific stock risk."

Basically, that's the risk that your investment may lose value not because of an overall market decline, but because of some unfavorable development at the company whose shares you own -- a bankruptcy, the loss of an esteemed executive, a scandal of some sort, or maybe just a thorough thrashing by the company's competitors.

Of course, you face this risk with any stock you own. But by spreading your money among shares of a dozen or more companies, you can limit the exposure to this risk in your portfolio overall. That's because the chances of all the shares you own simultaneously running into a problem such as a bankruptcy or corruption scandal are pretty small. That's the whole principle behind building a diversified portfolio.

But when you load up on shares of any individual stock, you're doing the opposite of diversifying. You're concentrating your holdings -- and increasing your risk.

Check your risk

Fortunately, there's a Web site that makes it pretty easy to get a good idea of just how much extra risk you're taking on as shares of one company become a larger and larger part of your portfolio. That Web site is called RiskGrades and it allows you to plug in all the holdings of your portfolio and get a risk score, or grade if you will, not just for each of your holdings, but for the portfolio overall. Indeed, it's the score for the portfolio overall that really counts because it reflects the fact that in a diversified portfolio, not all holdings move up and down in synch.

Just by way of example, I recently went to RiskGrades and created a portfolio that was 90 percent invested in the Vanguard Total Stock Market Index fund -- a fund that reflects the entire U.S. stock market -- and 10 percent in the shares of a single stock, in this case, my employer, Time Warner. The result was a grade of 45 for the entire portfolio, roughly the same as the grade for the U.S. stock market as a whole.

When I upped the portion of Time Warner to 50 percent of the portfolio, however, the risk score for the portfolio overall climbed to 57 -- a 27 percent increase. And when I boosted Time Warner shares to 90 percent of the portfolio, the risk score zoomed to 85 -- almost 90 percent higher than when I had only 10 percent of the portfolio in Time Warner shares.

Look at your portfolio overall

The object of this exercise isn't to make a point about Time Warner stock. Rather, it's to show that once you start concentrating a significant portion of your portfolio in the shares of any single company, you increase your exposure to specific stock risk -- and increase the level of risk in your portfolio overall.

My advice: don't let your attention be diverted by the 15 percent discount. What's really important is how adding shares of your employer's stock to the investments you already own affects the overall level of risk in your portfolio.

So before you start buying, check out the RiskGrades site and run a few scenarios with different levels of company stock holdings. This way, you'll be able to take advantage of your company's offer without putting your finances at undue risk.

Walter Updegrave is a senior editor at MONEY Magazine and is the author of "We're Not in Kansas Anymore: Strategies for Retiring Rich in a Totally Changed World."  Top of page

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