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Key lessons in investing

Amar Pandit in Mumbai | March 30, 2009 10:46 IST

Sagar Shah, who works for a leading cement company, was under the impression that he was in the best position to know about his organisation.

As a result, he invested a sizeable amount in his company' shares. In fact, more than 90 per cent of his portfolio was formed by this one firm only. His initial investment had given him a multi-bagger, but he was just not willing to sell when the stock hit Rs 950 levels.

Based on the tips given by his brokers and his own understanding of the cement industry, he bought a lot more stock and averaged his cost to around Rs 600. The stock has been beaten down to Rs 150 levels today.

There's no denying the fact that his company certainly is a good blue chip stock, but that does not mean that his exposure to it should have been at around 90 per cent of his portfolio.

These scenarios are often repeated during every bust and the last time we had witnessed this was during the 2000 dot-com bust. The players keep changing, but it's always the employees who suffer a double whammy.

However, when the going is good, it's very difficult for people who work for blue chip companies to see the big risk that they are exposed to: the risk of exposing their income and a substantial portion of their wealth to their employers' stock.

There are many behavioural finance reasons for why this happens. One reason is the comfort of knowing something too well and this tends to develop an over confidence in one's ability as well as in one's company and blue chip stock.

The logic goes like this, "We work for a blue chip company. What can happen to us? We have been clocking record growth and everything just seems perfect." 

However, this is a perfect recipe for disaster as many people have figured out in the current downturn. The worst hit are those who have been laid off and had held sizeable exposure to their employer stock.

In fact, there are many people who also hold on to their employers' stocks long after they have left the company. We come across several portfolios today that have more than 60 per cent exposure to Satyam [Get Quote], and several other such companies.

Some of them no longer work at these companies. Yet, the emotional bonding was too much for them to sell the stock.

This also applies to people who have acquired huge chunks of just one company through investments. Sure, a single company exposure can give amazing returns. But then it has the propensity to sink your financial ship. One of the key lessons is that never have an exposure of more than 10 per cent to any stock.

Even if the stock is a blue chip stock and you are fully confident of its ability, it still makes sense to spread the risk across many companies in different sectors.

Even if a Satyam goes down, you would still have an Infosys [Get Quote] or a TCS [Get Quote] in your portfolio. Again, this does not mean that you should over-concentrate on Infosys and TCS. The idea is to diversify across sectors and you will certainly be held in good stead.

Keep the following points in mind
Restrict your exposure to even a blue chip stock to not more than 10 per cent. However blue the blue chip is, do not forget this cardinal rule. This way, you will ensure that if the company goes bust and you lose your job, your fortune is not tied to that company or even that sector.

If you have got excellent returns from the stock and if valuations go beyond fundamentals, be ready to sell the stock. There is no need to marry any stock. Fidelity is certainly good, but there are times when you must sell a stock.

Evaluate every company unemotionally at regular intervals of 12 to 18 months and take a view based on the situation at that point of time. Just because Infosys had hit more than Rs 10,000 in 1999 does not mean it will hit these levels anytime soon or in the future.

See whether a company can deliver substantial returns in the future too.  If you are currently holding a sizeable chunk of stock in one single company, and it's not as down as other companies, you can utilise this time to exit and diversify.

Encash your holdings at regular intervals and rebalance your portfolio. If need be, book profits and move into debt.

The writer is a certified financial planner.

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