The Moral of the Enron Story: Diversification

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The Moral of the Enron Story: Diversification

Perhaps one of the most unfortunate aspects of the whole Enron fiasco is the loss of retirement savings by thousands of employees.

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Once upon a time, the top executives of a multi-billion dollar energy company forced the corporation into bankruptcy through pure greed and underhanded dealings. As of the writing of this article, the stock of this fallen giant has been depressed to a mere 15 cents per share.

Perhaps one of the most unfortunate aspects of the whole Enron fiasco is the loss of retirement savings by thousands of employees. In some cases, whole nest eggs disappeared. Imagine working for a company, putting in twenty to thirty years of your life, only to find that you can't retire because you're broke. Add insult to injury with the fact that your bosses were giving themselves bonuses and selling off huge positions of company stock while they told you to sit tight. That's essentially what happened here: Enron refused to allow employees to sell company stock under their 401(k) retirement savings. Traditionally, the captain is supposed to go down with the ship. In this story, not only did the captain jump ship, but he guaranteed a yacht for safe getaway while the deck hands drowned. And, the deck hands could have saved themselves if they'd only secured a few lifeboats. In this story, the lifeboat would have been a diversified portfolio.

Enron employees kept huge positions invested in company stock. Whether it was lack of knowledge, improper guidance, or an over zealous investment attitude, employees put all their eggs in one proverbial basket and are now in the uncomfortable position of having their retirement accounts essentially wiped out.

If only Enron's employees would have diversified their holdings. Diversification is one of the most important concepts when putting together an investment portfolio. It is achieved by mixing your assets between various types of stocks, bonds and other investment vehicles in order to minimize risk while maximizing return. As the Enron story shows us, even enormous companies that seem impervious to market conditions are not a sure thing. Diversifying your investment portfolio will help to eliminate specific investment risk. This is the risk an investor incurs by only investing in one company or a single market sector--like energy.

A properly allocated portfolio includes a multitude of investments in various sectors like utilities, durable goods, finance, and consumer cyclicals, just to name a few. Also, a nice mix of large, small, domestic, international, value, and growth companies should be included as part of a well-constructed portfolio. Why is this important? All of these asset classes respond differently in varying market conditions and in relation to each other.

Although it can be a very tedious and difficult process to properly diversify an investment portfolio, it doesn't have to be exact. A great way to begin is by purchasing shares in mutual funds. For an annual expense fee mutual funds offer investors professional portfolio management, instant diversification, and a host of other customer oriented services that take much of the guesswork out of individual investment selection. Some mutual funds own three to five hundred different companies found in all various sectors and size. So if one company does poorly or, worse case, declares bankruptcy, the mutual fund still thrives due to the many other companies that have remained steady or perhaps have increased in value. That's the beauty of diversification. It eliminates the chances of losing everything. What's the possibility that three hundred publicly traded companies are going to declare bankruptcy? Not likely.

Each mutual fund comes with a prospectus. A prospectus states all pertinent details about a fund, such as information about the manager(s), fund description, portfolio composition, return ratios, fees and expenses, what the fund can and can't invest into, investment philosophy, etc. It's important to read the prospectus to gain an understanding of what's being purchased and how the mutual fund will fit into the overall portfolio. (Click here to see a list of funds the pauper likes)

In a time where terrorist attacks, big business scandal, and general market fears keep investors waiting nervously on the sidelines, it's important to reflect on short and long term goals and ensure that investments match these goals. We can all take a lesson from the hard reality facing Enron stockholders: diversify, diversify, diversify.

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