On August 2, investors woke up to this news from Reuters:
“Knight Capital Group Inc. is being forced to raise money after an erroneous trading position wiped out $440 million of its capital, the firm said on Thursday, causing its shares to shed more than half of their value.”
Not only were the shares of the market maker down 50% in early trading, but they had declined -33% the previous trading day when news of their involvement in the erroneous trades broke. That’s a decline of nearly -70% in just over 24 hours.
This highlights the importance of diversification when it comes to your investments. We advise our clients to maintain no more than 10% of their portfolio in any given company, no matter how sound that company may appear. Things like erroneous trades, plant fires, and accounting scandals happen, which means that the value of any company’s stock can drop instantaneously. This is known as company-specific risk, and you can protect yourself from it by simply diversifying your holdings.
If you had half of your net worth in Knight stock, you just took a financial hit (-35%) that would be difficult to recover from. In contrast, by limiting your exposure to 10% of any given company, your net worth would be down -6% or -7%, not good news in the least bit, but not a death blow to your retirement plans either.