Monday, January 19, 2015

How many baskets are your eggs in?

Over the years I have frequently stated that most investors would be well served by maintaining a diversified portfolio. While I am certainly not alone in this opinion, I want to highlight exactly why I’m a strong proponent of diversification.

First, I have to acknowledge that some investors have indeed made a lot of money by focusing their investment dollars into one category, such as stocks or real estate. Others have garnered significant returns by putting all their money into just one stock.

So, yes, there is the potential to make a lot of money by putting all your investing dollars into a narrow category. But there is also significantly more risk.

Throughout my career, I don’t believe there’s a point of view I haven’t heard. One good example is real estate. How many times have you heard the “experts” claim that you could never lose money in real estate?

Recent history has proven that opinion inaccurate as both commercial and residential real estate have actually decreased in value. Unfortunately, many people learned the hard way by not only losing money, but also their residence.

It was a sad and expensive lesson, but it did conclusively prove that real estate values could fluctuate.

Gold is another poster child for fluctuation. For a long time infomercials flooded the airwaves advising everyone to buy gold for portfolio stability.

But it wasn’t stable. It’s down substantially, whether it was purchased in its physical form or as a stock or ETF. And investors who bought at the peak are a long way from getting their heads above water.

Another commodity that’s dramatically plummeted in market value is oil. If you invested in oil, you’re very likely to be hurting badly at the moment. My condolences.

Most investors are aware of the inherent risk in stocks. In the 1950s GM President Charles Wilson stated, “…because for years I thought what was good for the country was good for General Motors and vice versa.” At the time GM had an aura around it much as Apple does today.

Unfortunately, far too many people had a significant percentage of their nest egg tied up in GM stock. I’m not trying to pick on GM, but it is further substantiation that it’s inherently risky to put all your eggs in one basket.

Locally, there are two recent examples that even bonds carry risk. Going back to GM, during the bankruptcy bondholders who thought they were first in line took a back seat to the unions. And when the City of Detroit went bankrupt, city bondholders also took a significant hit.

I don’t want to come off sounding like a purveyor of doom and gloom, but the point is, to a certain degree, everything carries an element of risk. Most investors would be better served being diversified not only among various asset classes, but also diversified within each class.

For example, in a category such as domestic stocks, rather than putting the entire amount into just ABC stock, consider adding DEF. And maybe even XYZ as well.

Simply stated, in our unpredictable, constantly changing economic environment, I firmly believe that most investors will be better served in the long term by utilizing a well-balanced, diversified portfolio. But even that requires periodic review and modifications.

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