Diversification—eggs in many baskets

Put all your eggs in one basket, and watch that basket, a quote variously attributed to Mark Twain and Andrew Carnegie, is really bad advice. While Andrew Carnegie knew what he was doing financially, Mark Twain most certainly did not. So listen to me, not him (I know better than to invest in crazy printing press inventions the way Twain did).

Pinning all your hopes on the success of one thing–one investment, one college admission, one friend—is quite simply playing roulette and you’re probably going to lose. Here’s my rationale for diversification:

• If one basket goes kaput you don’t lose everything

• You can control your choices, but you can’t control external factors. Worry only about what you can control

• Sentiment on various investments can vary greatly. Some part of the time you’ll be in-sync, sometimes not. You have a better chance of success if things are not correlated or all the same.

Quantity is not the same as diversification. If you own Dell, Hewlett-Packard, and Apple, you’re not diversified. If your child applies to Harvard, Yale and Stanford, you’re not diversified. If all your friends are from Civil War re-enacting, you’re going to be pretty lonely in the wintertime. You have to make your investment in things with true differences. In financial terms, this is why I recommend index mutual funds and/or ETFs. Put 90% of your money into funds and you can own Dell, H-P, and Apple as one basket (nicely diversified within that basket but not necessarily one I recommend), but also a fund of small value companies, international bonds, REITs, or just about any other type of investment that might be suitable for you. You develop a suitable mix based on your goals, the amount of money you have to invest, and your tolerance for stomach churning. That’s one of the things a financial advisor can help you sort through.

On the other hand, you probably don’t need 65 different investments. Research has shown that more than about 10-12 core holdings begin to lose the value of diversification. You’re spread out among so many things that you have no chance of “beating the market”—you ARE the market. Plus, keeping up with what’s going on just becomes ridiculously time consuming. 10 or 12 mutual funds you can monitor, 25 individual stocks become your full time job, with no evidence that you’ll actually do better and probably do a lot worse than an index. Ask any big-time money manager. Ask Bernie Madoff.

You know all this already? Are you doing it? Are you in love with a stock? Holding it because it will “come back some day”? You inherited it from your dad who worked for the company forever? Um, were you formerly employed at Enron? Reserve your love for your friends, family, art, music, hobbies. Investments are just money—get professional advice and make rational decisions.

 

 

Posted in General Financial Planning, Investment Planning.

Leave a Reply

Your email address will not be published. Required fields are marked *

Time limit is exhausted. Please reload the CAPTCHA.