Diversification Key to Protect Wealth in a Turbulent Market

Last year William Giles, the CFO of Linens ‘n Things, resigned from the New Jersey-based company to become the new CFO for Autozone Inc., in Memphis. Autozone recently disclosed in its annual proxy statement that it paid Mr. Giles $245,100 in relocation expense, which was the loss incurred when the company purchased and sold his home over the course of one year. Autozone bought the home at its appraised value and less than one year later sold it for $245,100 less than the purchase price.

While the average homeowner is unlikely to see a $250,000 change in the value of their home in 12 months, all homeowners should consider the likelihood that their home equity is less than they think. And since most of us cannot rely upon a Fortune 500 company to pay us the “appraised” value if we decide to sell, we should carefully manage our home and the related mortgage debt to preserve our net worth.

Most homeowners can’t avoid borrowing money to purchase a home, but the days of the ATM machine in the garage are over.

Thus, I suggest borrowing against the equity in your home only if you must add square footage, and using disposable income or some savings to pay off credit cards, make car payments, or head to the beach. And consider waiting another year or two to remodel the kitchen; home prices should have stabilized by then, allowing you to make the investment based on a more accurate estimate of your expected return.

Likewise, never borrow against your home to invest in the stock market, even if there is a precipitous drop and stock prices are at multi-year lows.

In a housing market with soft or declining prices per SF, it’s prudent to keep as much equity in your home as possible, to avoid being upside down should you need to sell it.

Speaking of the market, let’s consider most homeowners’ other significant asset, their investment portfolio of stocks and bonds.

I hope you are maximizing your annual 401(k) contribution (or other qualified retirement account) and building a taxable investment portfolio with any excess disposable income.

If so, you have probably observed that the larger your portfolios grow, the more you notice the change in value when the stock market fluctuates.

Of course, you are understandably concerned about losing a large portion of your net worth.

You can protect your wealth by diversifying your portfolio into stocks that are unrelated to any sizeable assets you have.

For example, if your home represents the majority of your net worth, avoid owning stocks of companies that are dependent upon the residential housing market.

If you work for Wal-Mart or a public vendor and have a large position of restricted stock or options, make sure the other stocks you own are issued by companies not heavily dependent on Wal-Mart or consumer spending.

If you own a business that rents equipment to the oil drilling industry, diversify into non-energy related stocks.

Many investors believe that owning more stocks is the proper way to diversify and that a mutual fund, which typically holds about 140 stocks, is the simple solution.

Unfortunately, mutual funds only report their holdings four times a year and hold each stock less than 2 years.

Thus, it is impossible to know which stocks you own at any given time. In fact, it’s likely you will own the very stocks you are trying to avoid.

For example, about 75 percent of all the money invested in the stock market (including mutual funds) is invested in the S&P 500, and about 12 percent of the market value of those 500 stocks is comprised of companies that are sensitive to real estate.

If you own mutual funds, there is a good chance you have more exposure to real estate than you think.

Instead, I suggest owning a diversified portfolio of 15-20 stocks, each of which has been carefully researched and selected based upon the company’s investment merits and your unique financial position.

Preserving wealth requires more than saving money and investing it wisely. It also entails managing assets and liabilities, identifying the risks in one’s financial household, and having a well-planned investment portfolio that addresses your unique circumstances.

(Joe Chumbler, CFA, is co-owner of Boston Mountain Money Management in Fayetteville. He may be reached at [email protected].)