Retirees are unique investors because they are unable to replace their principal, which is necessary to produce fixed income to pay for living expenses. Decades of savings, not to mention financial sacrifices were done to offset lost wages in retirement.

As a result of investing for income, stockbrokers (one may view regulatory information about his or her stockbroker at https://brokercheck.finra.org/) often recommend retirees (or soon to be retirees) to invest in oil-related products due to the high amount of distributions issued by the underlying companies.  Many oil investments are mandated to distribute a minimum amount of profits to investors, which is a selling point used by stockbrokers.

While investing in oil sounds promising for a retiree, too much of anything can have negative consequences. 

FINRA, the entity that regulates the securities industry in conjunction with the Securities and Exchange Commission requires stockbrokers to "have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer, based on the information obtained through the reasonable diligence … to ascertain the customer's investment profile." [Emphasis added].

The rule further explains that a "customer's investment profile includes, but is not limited to, the customer's age, other investments, financial situation and needs, tax status, investment objectives, investment experience, investment time horizon, liquidity needs, risk tolerance, and any other information the customer may disclose to the member or associated person in connection with such recommendation."

The rule has a quantitative suitability component requiring the stockbroker "to have a reasonable basis for believing that a series of recommended transactions, even if suitable when viewed in isolation, are not excessive and unsuitable for the customer when taken together in light of the customer's investment profile. Factors such as turnover rate, cost-equity ratio and use of in-and-out trading in a customer's account may provide a basis for finding that the activity at issue was excessive."

With the oil implosion of recent weeks, stockbrokers may have difficulty justifying over concentrating retirees in oil-related securities, whether in individual securities or ETFs, such as SPDR S&P Oil & Gas Exploration & Production (Ticker "XOP");
iShares U.S. Oil & Gas Exploration & Production (Ticker "IEO”); and
Invesco Dynamic Energy Exploration & Production (Ticker “PXE”) all of which sustained not only devastating losses but in excess of market declines. 

Over-concentration may occur when the benefits of “putting all eggs in one basket” is outweighed by the risks.   Over-concentration applies to an individual security, a class of investments, or a market segment concerning an investment portfolio. 

Concentration risk is the potential for a loss in value of an investment portfolio when exposures move together in an unfavorable direction. Concentration risk implies that it generates a significant loss that recovery is unlikely, at least in the short-term. In addition, concentration risk can be found in various types of risk exposure, such as:

Market liquidity risk: The difficulties in liquidating, purchasing, or switching quickly investment assets are common problems for a large investment portfolio. Concentration risk is usually calculated by comparing the liquidity of assets to their risk exposure.

Credit Risk: The default of an individual debtor or a group of debtors in the same sector can be ruinous without sufficient diversification.

A first step determining if securities purchased for a customer were suitable is reviewing the “new account” document issued by the customer’s broker-dealer, which memorializes a customer’s net-worth, financial information, and overall station in life.  This new account document is crucial because management relies on this document to supervise whether the investments purchased for a customer were suitable and not concentrated.

Questions reputable firms ask customers prior to investing are:

• Is the customer currently employed? If so, how much longer does he or she plan to work?

• What are the customer's primary expenses? For example, does the customer still have a  mortgage?

• What are the customer's sources of income? Is the customer living on a fixed income or anticipate doing so in the future?

• How much income does the customer need to meet fixed or anticipated expenses?

• How much has the customer saved for retirement? How are those assets invested?

• How important is the liquidity of income-generating assets to the customer?

• What are the customer's financial and investment goals? For example, how important is generating income, preserving capital or accumulating assets for heirs?

• What health care insurance does the customer have? Will the customer be relying on investment assets for anticipated and unanticipated health costs?

Concentrating in oil has been compared to “backing up the truck” with unnecessary risk exposure.  For many customers, a stockbroker’s failure to diversify an investment portfolio may be the basis for fraud in relation to the customer’s profile and instructions.  If this is so, one may have legal recourse to recover avoidable losses.