Phoebe Venable: Egg idiom is good advice for investors

On Easter weekend, as we watch children gather brightly painted Easter eggs and place them in pastel-colored baskets, investors might be reminded of the idiom “don’t put all your eggs in one basket.”

This saying likely originated centuries ago, back in the day when people would go out to the hen house and gather eggs that their chickens had laid. If you put all of your eggs in one basket and then dropped the basket or the bottom fell out of it, you lost all the eggs: All your work gathering those eggs, not to mention the work of the chickens, had been in vain.

Instead of loading up one basket with all the eggs, if you put your eggs into multiple baskets and something happens to one of them, you still have other baskets with some eggs. This simple statement about jostled baskets and broken eggs is pretty easy to understand and apply to your investment strategy.

For investors, not putting all your eggs in one basket means your portfolio should be diversified. No matter how much you believe in one company or love their products, putting all of your “eggs” in any one investment is a recipe for disaster. If the bottom falls out of the only basket you have, you’ll be left with a broken portfolio and the damage from financial losses can impact your life.

While this may seem so clear and grounded in plain common sense, many investors lack diversification in their portfolios. The most common way this happens is through employment. Many corporations provide an employee stock purchase plan (ESPP) where employees can purchase, sometimes at a discount, their company’s common stock. Imagine the employee who participates in the ESPP, receives incentive stock options and also invests their 401(k) retirement plan in their company’s common stock. With a little bit of time, this employee is going to have a concentration in their employer’s stock. With a little bit more time, this investor will have unintentionally created significant risk for herself. If things go south for her company, the investor could lose not only her employment but her savings, too.

The concentration of both employment and wealth in a single company is just not prudent. The commonly heard rationale for this kind of concentration is “I work there and know what is happening with the company. Or “the wealth I have created is because I own so much of my company’s stock.” Regardless of the reasoning, any single holding that makes up more than one third of your overall investment portfolio is a concentrated risk and your portfolio lacks diversification. It’s time to get more baskets into your portfolio.

Diversification is more than owning different companies’ stocks. It is also important to diversify your stocks by different sectors of the market (such as health care, technology and banks) and by holding investment types beyond stocks, such as certificates of deposit, real estate, etc.

All that said, it is possible to have too many baskets. With all of the investment options that are available in today’s market, some well-intentioned investors have found themselves overdiversified. Yes, it is possible to go wrong on either extreme when it comes to diversification. With too many investment positions come unnecessary expenses in the form of fees and overall inefficiency: You may dilute your losses, but you’ll be diluting your gains, too. As Warren Buffett once said, “Wide diversification is only required when investors do not understand what they are doing.”

If you don’t have the time, knowledge or desire to complete the due diligence required for proper diversification, consider delegating this task to a financial adviser — and maybe next year, Easter baskets can simply be Easter baskets and not a metaphor for the safety of your life’s savings.

Phoebe Venable, chartered financial analyst, is president & COO of CapWealth Advisors LLC. Her column on women, families and building wealth appears each Saturday in The Tennessean.