I've lived through a few economic fiascos. Enron and WorldCom have both collapsed during my adult years. So did my bank (Wachovia) during the 2008 financial crisis. I'm not naive enough to think that major corporations can't fail.
That said, most corporations are not Enron or WorldCom. And when companies do fail, giant neon warning signs tend to flash before they implode.
There's also a pretty great way to mitigate your risk of loss: diversification.
Don't put all of your eggs in one basket is especially true for investing. Your risk of losing everything increases greatly when all of your money is concentrated in one company's stock.
Funds make it easy
Index funds track a broad stock market index, such as the S&P 500 or MSCI EAFE Index. Total market funds own shares of (almost) every publicly-traded company in the United States, giving you exposure to large, small, and mid-cap companies. Both ensure that you at least match the market's returns over time.
I prefer ETFs because they require less cash up front. Mutual funds typically have minimum investments in the $2,500 - 3,000 range. You can buy into an ETF for the cost of a single share.
Look for funds with low expense ratios (somewhere in the 0.03% – 0.5% range), and no transaction fees. Vanguard and Fidelity are the leaders in fund pricing. iShares by BlackRock and Schwab also offer low-cost ETFs.
Don't forget bonds!
Bonds are also part of a diversified portolio, whether held individually, or as part of a fund. Buying bonds through a fund helps ensure that you're getting bonds of different interest rates, default risks, and maturities, but your gains are offset by the fund's fees.
I prefer to hold corporate bonds through a fund. Funds also make it easy to invest in international government bonds. I'd rather have a knowledgable manager worry about diversification and risk when it comes to corporate balance sheets and foreign economies.
Research agency Morningstar has some bond fund suggestions. BuySide from the Wall Street Joural, has a smaller list of their
best bond fund picks. I like and own shares of their Best International Fund pick, Vanguard's BNDX.
I'm much more confident buying and owning individual U.S. treasury bonds and treasury notes. Although most brokerages sell treasury bonds, bills, and notes, you can also use TreasuryDirect.gov. Some brokerages only sell bonds and notes in $1,000 increments. TreasuryDirect sells them in $100 increments. You can also use TreasuryDirect to buy U.S. savings bonds, which you can buy for as little as $25.
When They Pay You In Equity
Diversication also applies to stock that you may receive as compensation.
Equity compensation and stock options can be a great way to build your wealth if the company is already publicly-traded.
Publicly-traded companies have to file quarterly and annual reports about their financial health and growth outlook. Stocks that are traded as part of an exchange (such as Nasdaq or the New York Stock Exchange) have established a market and value for those shares. You know that you are getting real wealth when you exercise those options or receive stock grants.
Still, there's an outside chance that your company is the next Enron. Or a billionaire might purchase the company and take it private. In both cases, the value of your equity can fall to $0. My suggestion is to sell some of your shares as they vest. Use the money to buy shares of a index or total market fund.
If your company is privately-held, I would suggest not exercising your options until it's clear that:
- the company is going to have an initial public offering soon; and
- that the share price will exceed what you've paid for it.
Otherwise, you're buying paper and hopes. I think it's an unnecessary risk.
Now, I'm obviously not a financial advisor. This is most definitely not financial advice. These are, however, things I've put into practice, and I think they're good things to do.
While you're here: Listen to
Bad Bets, Season 1
Bad Bets is a podcast series from the Wall Street Journal. Season 1 looked at the collapse of Enron over the course of eight episodes. It features an instructive tale of one employee who lost everything because all of his eggs were in one Enron-shaped basket.
I've linked to the audio and transcript of every episode below.
- Enron, Ep 1: Potemkin Village
- Enron, Ep 2: The Visionary
- Enron, Ep 3: The Fixer and the Whistleblowers
- Enron, Ep 4: The Downfall
- Enron, Ep 5: The Enablers
- Enron, Ep 6: Lies and Choices
- Enron, Ep 7: The Trial
- Enron, Ep 8: Vigilance and Skepticism
Season 2 looks at Nikola Corporation and the downfall of its founder, Trevor Milton. Nikola, as you may recall, promised zero-emissions trucks and could not deliver. Season 2 is also worth a listen, but it's more of a fraud/scammer tale.
Exchange traded funds trade like stocks. The price can fluctuate throughout the day, and you can buy or sell at any time during the trading day. Mutual funds are priced and traded at the end of the trading session. This is to discourage fund holders from withdrawing their money too frequently. If the market drops significantly in one day, you can't sell your mutual fund shares. You can, however, sell your ETF shares. Selling off shares isn't necessarily the best move when the market is plummeting, but you can do so with an ETF. ↩
I'm partial to the Vanguard S&P 500 ETF (VOO). It's the exchange traded version of the Vanguard 500 Index Fund (VFIAX). Both track the S&P 500 index. VFIAX requires a minimum investment of $3000. One share of VOO has ranged from about $320 – $440 between November 2021 and November 2022. VOO also has a slightly-lower expense ratio and no transaction fee at most brokerages. ↩
FSKAX is a total market option from Fidelity. Schwab offers a Total Stock Market Index Fund (SWTSX). Vanguard has a Vanguard Total Stock Market ETF (VTI). There's also the iShares Core S&P Total U.S. Stock Market ETF (ITOT). ↩