Behavioral Investing and Finance

We know the saying about dating. “Don’t fishing from the company pond,” which means don’t date anyone from the company you are working for because if the relationship does not work out, you will see that person every day, which would be awkward. Funny that the same is true for investing more money in the company you are working for. Don’t do it.

When we work for a company, we feel we have more insider information than the public on the company, how well sales are going, how well production is meeting goals, and how little churn you see. You also get internal company news from the CEO or Executives regularly, so we feel we are experts on our company. However, that may be a fallacy. Unless you are the CEO or CFO, you may not know everything that is happening; including how much debt they have, high AP outlays, slow AR collection, or how much money the company is burning.

Familiarity Bias

Because you are very familiar with your company, you have biases toward the company vs. other companies out there. You feel your company is less risky and will do better than others. This is the same bias that you have when you are rooting for your local sports team. You feel your local team is better than your opponent when it may not be. I definitely have this bias for my California Bears football team.

With this familiarity bias, many people will feel like they should invest their 401K into the company stock vs. buying other stocks or bonds because they feel it is less risky. It is not. Let’s talk about an example of Tesla stock (TSLA). Suppose you invest $80,000 a year in TSLA, and you have $5,000 more to invest per year. Would putting the rest in TSLA be a risky or non-risky move? It is a very risky move as you have no diversification. If you were a reasonable investor, would you do that? Probably not.

However, if you worked for Tesla, making $80,000 per year, you might consider putting that $5000 into TSLA stock in your 401K because the company has been doing well. Like the previous example, you still put all your eggs in the TSLA financial basket and not diversifying.

Enron Debacle

Let’s take the example of ENRON, a high-flying energy company. At peak stock values, 60% of Enron employees’ 401k assets were invested in Enron stock. 60%!! The employees knew the company, listened to their leaders, who were lying, and saw the stock continue to rise, so they thought, why not invest in Enron stock. Then Enron went bankrupt, and the employees lost their jobs and much of their retirement savings. In fact, the employees lost $1.3 billion dollars from their 401k.

Diversification is key

I love the home team as much as the next guy, but I learned not to invest too much into my college sports team or my company stock. Putting your salary and investment into one company is highly risky. As you put money into your 401k, IRAs, or other investments, look to invest in other areas like foreign stocks, bonds, world stocks, or other domestic stocks. That will help smooth out the risk profile of your portfolio, and even if you lose your job, you still have that nest egg.

Side note: I know married people who work for the same company; not a family business, but a separate company, which is also very high risk. You are putting two salaries in one company, and if the company folds or does a massive layoff, you might both be out of a job. Something to think about in terms of personal finances.