Diversify Your Investments

The past few years have been good for America's home builders, and I assume many have accumulated excess profits in their business accounts or socked away investment capital in their personal accounts. But to builders who poured some of those gains into investments related to the housing industry, let me add a cautionary note.

It's not uncommon for builders to invest in the industry they know best. Thus, you'll find builders who buy real estate (e.g., residential and/or commercial rentals) because they understand how to value and purchase property. They're also comfortable with the players involved in the process - Realtors, attorneys, appraisers, et al.

Additionally, builders who invest in the stock market might purchase shares in companies they know—publicly traded home building companies or publicly traded building product manufacturers or distributors that sell products used within, or to construct, homes.

Their investments even might extend to buying stock in banks and mortgage companies that provide financing to purchase these types of properties.

What Happens in a Downturn?

While the housing boom has been kind to many of these types of stocks, there are performance correlations between many of these companies. And therein lies the problem: Builders who put many of their investment eggs into the housing basket might suffer significant (and disproportionately large) losses when, and if, the housing markets turn down. Thus, when a publicly traded home building company declines in value, so might related entities such as housing suppliers and banks.

It's critical that all investors diversify their investment portfolios. To cushion their companies against localized slowdowns within the building industry, diversified builders can take similar steps. They might build in multiple markets, construct varied types of residential housing or mix in commercial projects aside from their residential work. The same is required in investing.

As I frequently tell clients who want to invest predominantly in the companies where they work (because they know those companies best), diversification entails spreading risk, not concentrating it. Builders who earn their income from residential construction and then invest the majority of their investment capital into companies directly or indirectly related to residential construction will suffer multiple losses when (not if) that sector slows. (What happened to Enron employees when that company collapsed? They not only lost their jobs, but any pension account dollars invested in Enron stock were obliterated as well.)

While I concede that placing large bets on single sectors can be hugely profitable (do the math on how much $50,000 invested in Microsoft in its early days would be worth today), builders who are investing for retirement must consider overall portfolio volatility. Portfolio values are subject to wild swings if investments are concentrated in just a few, volatile sectors.

Builders who want to insulate themselves from inordinately large losses when the housing markets slow should examine their personal portfolios carefully. Investing where you know best might appear logical, but not if it can jeopardize your family's future.