By: Roshawn Watson
All it took was one night to wipe out David Shorr’s nest egg. As a former Lehman Brothers employee, David’s investments were heavily concentrated in the beleaguered financial firm. Recent news of the company’s troubling financial problems has caused his stocks to plummet, and his benefits are now worthless.
In the New York Post, he was quoted as saying “I lost over $6 million overnight…I’m wiped out.”
Image Credit: TW Collins
Blame Game
David places blame on the CEO for his losses, but I wonder whether he takes any personal responsibility.
After all, as someone with years of experience in finance, why didn’t he diversify?
The primary purpose of diversification is to minimize risk by spreading those investment dollars. Not to sound too harsh, but when he made the decision to invest in excess of $6 million in a single company, that’s when he lost his money. He just had a delayed “day of reckoning,” so to speak (more on David later).
Why People Don’t Diversify
To be fair, not everyone is a fan of diversification. For example, by investing in a broad range of securities, diversified portfolios also reduce the upside potential of winners (great individual stocks). This is perhaps the primary reason why most do not diversify: they are trying to beat the market. I suspect trying to beat the market motivated David to concentrate in Lehman rather than diversify. The caveat is the odds are against those who concentrate in a single stock. Famous investor Peter Lynch has been quoted saying in his line of work, if you were right six times out of 10 times, you’d be pretty good. In other words, picking individual stocks that are winners is difficult, even amongst the most skilled professional investors.
Diversification with individual stocks can also pose a challenge: it can be pretty expensive because it is often recommended that someone have at least 10 stocks for a reasonably diversified portfolio (some suggest even holding 40-50 stocks). For small, retail investors, this requires a lot of income and time.
Primary Benefit of a Diversified Portfolio’s
By developing a well-diversified portfolio, one can avoid some of the biggest challenges the financial markets throw his or her way. With diversification, as one part of the portfolio is down, other investments rise in value, offsetting or even outweighing those losses. Proper diversification provides smooth, steady growth while reducing the volatility.
Concentrated Investing Approach (a.k.a. focused investing)
Even if you don’t wholly subscribe to the diversification philosophy, carefully consider your holdings because it is possible to diversify and concentrate at the same time. For example, if you carefully choose 10 to 12 really great stocks in different sectors, it is perfectly possible that you can achieve just as much diversification as someone with hundreds of individual stocks or a mutual fund or index funds without the heft. Perhaps the most compelling reason for this strategy is that individuals who win the biggest with investing often make the majority of their money on just a few great picks. Warren Buffet, for example, made some extraordinary returns by big investments in companies such as Washington Post and American Express. Although actively managing 10-12 stocks can be time-consuming, it definitely offers substantial risk-reduction compared to owning a single company stock, such as David Shorr’s Lehman investment.
Back To David
Although David Shorr’s story of gambling and losing is quite sad, currently he is employed as a senior vice president at Morgan Stanley as a wealth adviser. Hopefully, he will not only get a second chance to rebuild his investments but will be able to spare someone else the pain of making the same mistake.
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Copyright 2008, Roshawn Watson, Pharm.D. All Rights Reserved.
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Its good to see he's landed on his feet with the new job…but I'm not so sure I'd want him as my wealth adviser given his current predicament and your comments about the strengths of diversification. From reading the NY Post article, I'm getting the impression he put all of his eggs in one basket for his retirement fund and has nothing else to fall back on.
I share your same concerns regarding taking his advice. It would seem reasonable that he would have a large income in his current position at Morgan Stanley. He should be able to rebuild at least some of his fortune, especially if he doesn't have too many liabilities.
You know, I had some sympathy for the employees of Enron several years back. When many of them lost so much of their nest eggs, I thought it was unfortunate but also a HUGE wakeup call to investors everwhere.In this day and age, someone who is obviously educated and knowledgeable of finances gets much less of my sympathy. This smacks of greed. And I agree with your statement about personal responsibility!
Retire @ 47,Enron is a great reference. You would think that someone who has seen this scenario play out repeatedly would have a lower degree of risk tolerance.
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