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
It's hard to create a truly diversified portfolio on your own, so take the easy route. Buy shares of a mutual fund or exchange-traded fund (ETF). "Index funds" or "total market" funds are best.1
Index funds track a broad-based stock market index, such as the S&P 500 or MSCI EAFE Index. Total market funds own shares of (almost) every publicly-traded company. Both ensure that you at least match the market's returns over time.
Look for funds with low expense ratios (less than 1%), and no transaction fees. Popular Vanguard and Fidelity index funds have expense ratios in the 0.03 - 0.15% range.
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 and maturities.
Go for bond ETFs, since they require less cash up front. Mutual funds typically have minimum investments in the $2,500 - 3,000 range. You can own an ETF for the cost of a single share. Ratings agency Morningstar has some bond fund suggestions.
I prefer to hold corporate bonds through a fund. Funds also make it easy to invest in non-U.S. government bonds. I'd rather have a knowledgable manager worry about diversification and risk when it comes to corporate balance sheets and foreign economies.
I'm much more confident buying and owning individual U.S. treasury bonds and notes. Although most brokerages sell treasury bonds and notes, I like buying them through TreasuryDirect.gov. Some brokerages only sell bonds and notes in $1,000 increments. TreasuryDirect sells them in $100 increments.
When They Pay You In Equity
This also goes for 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 babillionaire 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 mutual fund or ETF.
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.
I'm partial to the Vanguard S&P 500 ETF (VOO). It's the exchange traded version of the Vanguard 500 Index Fund (VFIAX). Exchange traded funds trade like stocks. The price can fluctuate through out the day, but the advantage is that you can invest in the fund for the cost of a single share. Mutual funds, on the other hand, require a minimum investment. They're also priced and traded at the end of the trading session. This is to discourage fund holders from withdrawing their money too frequently. 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. Buy the ETF. Hold on to it. Regularly purchase shares as though it was a mutual fund. ↩