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Diversify your life

However, today when Employee Stock Options are a big part of some people’s exposure to the stock markets, diversification must start with diversifying one’s life, not just one’s investments, writes Dhirendra Kumar.

india Updated: Mar 23, 2008 23:31 IST

I have a friend who works at a fairly senior position in a large bank. A considerable proportion of his investments are the stock options he has received. As it happens, this bank is prone to periodic rumours about being in trouble of one kind or the other. In recent weeks, just as all of my friends’ investments have fallen, those of his employer (and other potential employers) have fallen the most.

Then there’s this couple I know who work in a large IT firm. Predictably, a good amount of their investments are in their own company’s stock options. They are now coming to grips with the possibility that if the rupee keeps gaining strength, employment growth in the IT industry could slow down and perhaps even sharply reverse. That’s a double problem. Realisation dawns that the permanently bright future that their industry was supposed to have may not exist. And, at the same time, their investments in their own employer have declined to less than half in about a year’s time. Like many IT stocks, their employers’ stock too hardly rose when the markets were rising but fell with great speed when the markets fell.

From America comes the news that around 30 per cent of the stock of the almost-failed Wall Street firm Bear Stearns was held by employees. The value of this stock declined by about 96 per cent in a matter of hours just as many of these employees were facing up to a future without jobs.

The point I am making should be obvious by now. Diversification is supposed to be the most important part of any investment strategy. You are supposed to spread your investments across different sectors and industry so that bad times in one may be offset by another. However, today when Employee Stock Options are a big part of some people’s exposure to the stock markets, diversification must start with diversifying one’s life, not just one’s investments. Your career is tied up with a particular industry, so your stock investments must necessarily be as far diversified from that industry as possible.

However, for a variety of reasons, the reverse seems to be true. The biggest reason seems to be that many of the employees of who receive ESOPs are otherwise not stock investors. They never buy any other stock or mutual fund and thus have 100 per cent of their investments in their own company. What’s worse, I hear that some companies have a culture of bias against selling ESOPs and employees face a subtle pressure against selling. Even worse, talking to some ESOP-holders about their investments, I’ve realised that even when they diversify, they have a tendency to buy the stock of other companies in the same industry, probably because they feel they understand the industry or they admire another company in the same industry. This is illusory diversification. Maruti employees buying Tata Motors stock or Satyam employees buying Infosys stock may feel like they are diversifying but they are not.

So what should you do with your ESOPs? Whether you otherwise invest in stocks or funds or not, the logic of diversification is very clear. You must sell your ESOPs as soon as you can. There’s a huge range of alternative investments that you can choose from. Tying up both your career and your savings to the well being of the same company (or the same industry) is clearly a case of putting all your eggs in one basket. And that’s never a good idea.

The writer is CEO, Value Research India Pvt Ltd