FOCUS ON PERSONAL FINANCE
Let Enron's Story Be a Lesson
Putting too much money in any one stock can be a disaster.
BY RICHARD J. ALPHONSO, JD, CPA/PFS, M.S.T., AND RAYMOND HAWKINS, MBA, CFA

Just last month, energy giant Enron Corp., which had been listed at No. 7 on the Fortune 500 list, filed for Chapter 11 bankruptcy protection in the biggest such filing in U.S. history. Although such filings have become all too common with the former dot-com darlings, Enron had appeared to be a solid, blue-chip company. And while analysts attribute Enron's rapid decline to risky speculation in a variety of energy markets, the lesson to investors is clear. Don't concentrate too much of your holdings in any one security.

In this month's column, we'll discuss the reasons investors overdose on one security. We'll also recommend solutions to this common problem.

WALL STREET LOSES CONFIDENCE

The Enron example painfully illustrates that even major companies can suffer financial reverses that snowball into disaster. The precipitous decline in Enron reflects a loss of confidence in the company caused by huge losses in the third quarter of 2001, and repeated misstatements of earnings. There are also revelations, now being investigated by the Securities and Exchange Commission, that some company employees participated in and profited from partnerships designed to keep debt off the balance sheet. As Enron's sad story unfolded, the company's stock price plunged from a high of $90 in February to less than a dollar, crushing investors who had placed a large percentage of their savings into Enron.

The Enron example should teach us all a valuable lesson about the importance of limiting risk in our investing.

In health care in general, as well as ophthalmology in particular, we see other painful examples of stocks suffering staggering drops. VISX, which develops systems for laser vision correction, went from a high of nearly $100 to a low near $10. McKesson Corp., a healthcare services and technology company, fell from a high of nearly $90 to about $15 before settling near $37. And don't think bonds are immune. Remember Washington Power's so-called Whoops bonds a few years ago? The list goes on.

SCENARIOS FOR DISASTER

Why do investors get burned so frequently? You might acquire a security over time that appreciates so greatly that emotion rules the day and you can't quite make the decision to sell. Perhaps you inherited the security, and your tax cost is so low that you can't stomach the tax hit -- so you hold on and wind up with a big loss. Sometimes, you can't legally dispose of the security because of an insider's lockup, short-swing profit rules, or you're involved in an ESOP (employee stock ownership plan).

During the bull market, we encouraged investors to diversify out of concentrated equity positions. However, acting on that advice was a challenge when a stock appeared to defy gravity.

We've long preached that investors must reduce risk by spreading their capital across a broad array of stocks, bonds and cash. What the recent bear market has taught us is that diversification across major asset classes isn't enough. Diversification within an asset class is equally important.

DIVERSIFY FOR SAFETY

Your equity portfolio should be diversified across market capitalization (size), geography (foreign vs. domestic), style (growth vs. value) and industries. And you must establish predetermined target portfolio percentages with constant rebalancing. That means every quarter or year, you're repositioning your holdings to achieve balance.

Concentrated equity positions have created some great success stories in this country, but they've also produced many heart-wrenching financial failures. Diversifying out of a concentrated position requires careful planning, along with a lot of financial guidance. If your portfolio isn't balanced, consult with your advisor now to prevent what could be a major financial reversal.

Richard J. Alphonso, JD, CPA/PFS, M.S.T., and Raymond Hawkins, MBA, CFA, are president and investment analyst, respectively, of The Financial Advisory Group, Inc., in Houston. The Financial Advisory Group (phone: 713-627-7660) provides personalized fee-only financial planning, investment management and business consulting services.