Before proceeding I will like to pose a simple question. If you are obligated to invest in only one company and you are given following two companies, which company would you like to invest:1) Procter & Gamble
2) SOH Manufacturing
I actually know your answer; majority of readers would have selected Procter & Gamble, Why? Actually in behavioral finance (or finance psychology) it is called familiarity bias, i.e. when given an opportunity to invest, people usually choose companies with which they are familiar. Everyone knows about Procter & Gamble as it is an international company and has a very strong and probably the strongest brand recognition. There is a very good chance that SOH Manufacturing share might give you a more profit as its share may be undervalued. Remember, every good company does not translate into a good investment, even a poor company if its share is undervalued. If a share of good company is worth 100 and it is trading at 110 it might not be a good investment. On the other hand, if the share of poor company is worth 10 and it is trading at 5 then this poor company might be a better investment.
Now since most of the people are most familiar with the company they are working for, they usually invest in their company when given an opportunity (familiarity bias also comes into play when people invest in companies situating in their locality). They fail to recognize that by investing their “financial capital” or “saving capital” in their employer they are actually making their financial position vulnerable. Suppose if your company gets into trouble you might loose your job because in bad time company layoff its worker and go towards downsizing. However just when your job is in danger your saving portfolio would also be diminishing in value because the share price of “troubled companies” goes down. When you loose your job, you will depend on your “savings” for the time you are unemployed so your “savings” diminish just when you need it the most.
Solution is very simple; diversification should be the principle of investment. If you have invested 100% or even more than 20% of your saving in your employer, you might be very vulnerable. I mean financially off course.
I am not saying that one should not invest in their employer at all, if you really know you company and your company share is a good investment, you should invest in it. But don’t “over invest” in your employer, after all “over investing” in any company can be harmful but “over investing” in your employer might harm you more as I described earlier.