Diversification across different industries reduces investment risks

This article was provided by Timothy M. Reese, senior vice president-investments with A.G. Edwards & Sons Inc.

Many companies offer their employees a stock purchase plan, enabling them to purchase company stock at a discounted price and invest in the company they work for and help build.

While this can frequently be a great way to invest in the stock market, many investors question whether it's good to load up on their company's stock - or any company's stock, for that matter.

Investing in your company's stock may be a good idea, but you need to set some guidelines and strategies to diversify holdings not only among individual stocks other than your company's but among industry sectors, as well. Doing so may help reduce the effects of the price fluctuations that will undoubtedly occur in your portfolio.

As you decide whether to participate in your employer's stock purchase plan, keep in mind that owning too much of any single stock is rarely a good idea. While you may be confident of your company's prospects for success or want to demonstrate your loyalty to your employer, you need to recognize that you may take on additional risk if you don't diversify.

Also, as you evaluate your holdings, don't overlook the potential danger in concentrating your investments within one industry, even if you spread your investments among several stocks in that industry. Often, when bad news hits one stock in an industry, it can also have a similar impact on other companies within the same sector.

So, what is one way to help reduce the risk in your portfolio? One way to protect yourself is to diversify your portfolio among several stocks.

In addition to your company's stock, you should try to broaden your equity holdings to include 20 to 30 stocks in at least six to eight industry sectors with different investment characteristics. Keep in mind that no more than 25 percent of your total portfolio value should be in any one sector.

Furthermore, another good rule of thumb is to have no more than 15 percent of your total portfolio including your 401(k) and individual retirement account in one stock. You should also strive to maintain a balanced asset allocation with not only stocks in different industries, but bonds and other investment vehicles, as well.

Once you have reviewed your portfolio and evaluated your investment objectives, you may realize that you have a concentrated position that is, you have too much of your holdings in a single stock or you are heavily invested in a single industry sector. If this is the case, it is a good idea to contact your financial consultant and discuss strategies for reducing your concentrated holdings.

The most common way to accomplish this and reduce your position is to gradually sell off the stock. This will help you control the amount of capital gains taxes you will owe on any gains resulting from the sale of stocks in your taxable accounts. There also are a few other strategies your financial consultant can suggest that can help you reduce the risk involved in having concentrated positions in both taxable and tax-deferred accounts.

Your investment objectives, risk tolerance and time horizon will dictate the appropriate asset balance for your financial situation. Because every investor has different investment needs, seeking the help of a financial consultant is usually the best alternative to avoid keeping your eggs all in one basket.