What Investors Can Learn From The Enron Mess

The largest bankruptcy in u.s. history offers valuable lessons on how you should invest in today's market

to be heavily scrutinized by individual and institutional investors alike. “And auditors will force companies to adhere more closely to GAAP (generally accepted accounting practices),” he says.

Stocks from a number of companies that have restated earnings have been hammered on Wall Street. Such blue chips as Procter & Gamble (NYSE: PG), AOL Time Warner (NYSE: AOL), and General Electric (NYSE: GE) have been among them. It appears that the more complex the entity, the bigger the sell-off from investors. Take Tyco International (NYSE: TYC), the industrial conglomerate that was once the darling of the Go-Go ’90s. The stock plunged to a staggering 49% in the first four weeks of 2002, due in part to its complicated structure and questions about its accounting practices. Adds Ripoll: “The question [is whether] investors see Enron as an isolated incident or will they feel that the system has been abused for years.”

The Enron mess provides solid lessons on investment decision making and portfolio protection in today’s environment. Heed the following:

Lesson No. 1: Diversify your investments
There’s one rule of risk management — diversification. Before you think about making an investment decision, clarify your investment goals and then structure an asset-allocation model to help you achieve them. Your diversified portfolio should extend across a range of asset classes, including stocks and bonds. (See “Getting the Scoop on Investing,” this issue.) The most devastated Enron employees were those who neglected to hold a mixed bag of assets. “The notion of diversification has won out because portfolios that were properly diversified have not been experiencing these pains,” says Garry Bridgeman, a certified investment-management analyst with Merrill Lynch. “The more evenly your funds are diversified, the less risk is built into the portfolio. Maybe you don’t have the maximum upside potential, but you’ll stay in the ball game and have a much more [consistent] rate of return over time.”

Lesson No. 2: Limit single investments
Don’t invest heavily in a solitary stock, bond, or security. Even if your employer seems like a sure fire or safe investment, such a tactic can actually place your portfolio in jeopardy. The Enron employees broke this rule, placing as much as 62% of their 401(k) money in company stock. To make matters worse, Enron matched employee contributions with company stock. And 25% of companies with 401(k) plans make matching contributions in the same manner.

According to the Institute of Management and Administration Congressional Research Service, corporations with retirement savings plans where company stock dominated total assets included Procter & Gamble (94.7%), Sherwin-Williams (91.6%), Abbott Laboratories (90.2%) and Pfizer (85.5%). For other company stock-laden 401(k) plans, see chart “Risky Business.”

Like Enron, 85% of these plans restrict the sale of their stock, and many force employees to hold their shares until age 50. Companies often change 401(k) administrators and place “lockdowns” — also known as “blackouts” and “quiet periods” — on retirement savings plans, restricting employees from making any investment changes until accounts are transferred. Enron employees were prevented from moving out of company stock as

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