Now that JPMorgan Chase has racked up losses of $2 billion and counting from risky derivatives trading, many individuals may be relieved that they have avoided this type of investment like a bad cold.
After all, most individual investors don't have the money or the stomach for such complex, high-risk investments. Yet that doesn't mean that they're aware of the risk levels posed by their portfolios of conventional investments. These risks could be far greater than you ever imagined.
Often, such risks can be discovered not by turning over every rock, but by looking at your investment landscape from a high vantage point. Looking at your holdings from a detached distance, you'll be better able to see risks may that have been lurking in your portfolio year after year, threatening or actually reducing your investment returns.
One of the most common risks imperiling portfolios is being over-invested in a single company. Routes to this risk include:
• Investing too much in a company that looks hot. In the late 1990s, Enron was a high-performing stock, and many investors bought in high -- only to regret it. These investors, and those who owned Lehman Brothers in 2008, were pummeled when these companies went bankrupt. The answer, of course, is diversification: spreading your investment among different companies in different industries.
• Owning too many shares of the company you work for — meaning that your employment income and your financial future are linked directly with the fortunes of the same company. If you work at a company that offers stock options or discounted shares, and you've taken advantage of this benefit, there's a good chance that you own way too many of your employer's shares for your own good.
Offering equity to employees is a time-honored way for companies to encourage employee loyalty and give them a strong incentive to work hard to increase the company's value. But over time, you can get over-weighted in this equity, increasing the chance that if you lose your job because of poor corporate performance, your nest egg will shrink when you need it most. Most Enron employees had a high concentration of Enron stock in their portfolios, so they had little to fall back on when they hit the bricks.
To reduce this risk, consider selling some of your shares gradually over time. If you think this is disloyal and you work for a public company, you might want to have a look at your top bosses' trading filings with the Securities and Exchange Commission. You'll see that many of them regularly sell shares. After you sell some of yours, consider investing the money in completely unrelated companies to diversify your portfolio to lessen risk.
• Being over-invested in a community where the local economy is dominated by a single employer. If you live in a small town where nearly everyone works at the same large employer and the bottom falls out after you've purchased rental property, you'll probably have to lower these rents to get tenants. This is especially distressing if you yourself work at the big employer.