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Much has already been written about the fall of Enron. Most has been on the political and business ramifications and deciding who to blame. I've been surprised to see that there hasn't been much that would help the average Joe protect himself from the next Enron. So let's see what lessons can be learned from the current mess.
There will always be bad guys in this world. Insiders will know more than you do. Some will use that knowledge to their advantage. And, some won't care if you get hurt while they make money. That's no surprise. Never trust the insiders to be on your side. Always take steps to protect yourself. You may be fortunate enough to avoid the bad guys. But you still need to be cautious.
If you can't explain what a company does in two sentences you shouldn't invest in it. Smoke and mirrors are only fun at the carnival. Razzle, dazzle companies often blow up. Complicated dealings are a perfect place to hide mischief. If you don't understand what a company is doing you won't be able to tell whether they're doing it well. You shouldn't invest in anything where you can't judge their performance.
Even the biggest of companies aren't immune from failure. Sure, they're safer. But not 100% safe. In fact, it's easier for a big company to hide troubles. At least until they become really serious.
Putting all your eggs in one basket is dangerous. It is not a good idea to have all of your assets invested in one company no matter how good that company is. Even if it's your own business it is wise to try to have your money invested in a number of different things.
Diversification is the most important tool for small savers and investors. It minimizes your damage when catastrophe strikes a company. And, it also provides for a steadier, more dependable growth of your money.
Mutual funds can protect you from being overly exposed to one bad apple. Even if a fund does own the next Enron, it's only a small portion of the fund.
Diversify your 401k plan. You shouldn't put all of your retirement money in one investment. You should have a variety of stocks, bonds and guaranteed investments. And even within each category you should have a variety of stocks and a variety of bonds.
You don't want to invest too much in the company you work for. If something bad happens to the company you could lose your job and your savings. Even if the future looks bright for your employer it's a bad idea.
Some employers will automatically buy company shares with their contribution to your 401k plan. You can still protect yourself from disaster. Use your contribution to buy something besides company stock. And sell the company shares in your account as soon as you can to keep your exposure to a low level. These two steps will provide needed diversification.
If you don't have control over an investment you've increased it's risk. Some 401k plans place limits on how soon you can sell the company's contribution. That means that you can't really count on the value of company contributed shares until you have the right to sell them.
When plan administrators are changed most 401k plans will freeze your investments for a short time. A lot can change in that time. If you face a freeze, you should consider moving the vast majority of your money into the safest place you can find. Often that's a CD or money fund within the 401k. You can always rebuy the stock or mutual fund once you regain control of the account.
Counting on others to protect your money doesn't always work. Even the most honest accounting and regulatory groups can make mistakes. And, some of them will even be dishonest (gasp!). Putting all of your money in one company and assuming that the auditors will catch any problems is foolish.
A big failure like this doesn't mean that you should avoid Wall Street and all stocks. Doing that would eliminate the best way to grow your money. Stocks have the best long term growth rate of any investment category.
We'll probably see some changes in the law. But you don't need to wait for Congress to protect your money. You can use common sense and diversification to protect you today. Why not take a look at your statements and make sure that you won't be a victim of the next big business flame out?
Gary Foreman is a former Certified Financial Planner who currently edits The Dollar Stretcher website www.stretcher.com/save.htm You'll find hundreds of free articles to stretch your day and your budget. If you have a question or comment send it to gary@stretcher.com
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