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.



Market Turmoil–here we go again

You remember the last time, right? For me, it’s actually which last time–the tech bust in 2002, the October crash in the 80s, the flash crash, the hyper-inflation during the Carter administration?–and since I’ve been around long enough, I’ve heard at least a dozen times, “This time it’s different”. Uh, no, it’s not. It’s still scary. The market will always be unpredictable. In your investing life you can absolutely count on several dramatic crashes. You will see your net worth and investment value take plunges worse than an unmoored elevator.

My nomination for dumbest guy on the planet was interviewed in the Wall Street Journal this morning. Apparently, he was watching the ticker when Apple stock took a plunge, so he sold a chunk. But according to the WSJ, when it began rising later in the afternoon, he was off line and missed buying it back on the upswing, for which he was regretful. Dumb as a box of rocks. Has this idiot never seen the advice to sell high and buy low? Sadly, he has had plenty of company in the last few days.

For about a year now, I’ve heard people bemoan how they shoulda’, coulda’ bought in March, 2009 (instead of going to cash or bonds, as most did) and what a great stock market run up they therefore missed. And so what is the average investor doing since Monday? Going to cash and bonds. I don’t know why people can’t get this right–maybe it’s the same as learning to steer into a skid–just too much against instinct.

What you should be doing right now is laughing at the market. If you follow the advice of your friendly neighborhood financial planner (me!) you’d have an appropriate asset allocation plan in place–a diverse basket of investment types, including a cash emergency fund, stocks, bonds, real estate, and internationals. And some of them would be sinking like a stone. In fact, I can pretty much guarantee that your net worth has dropped in the last few days. No one can diversify out of all market risk and in our very interdependent world, it’s next to impossible to find investments that are negatively correlated. But diversification can limit and protect that risk as much as is possible in a turbulent world. If the zombies arrive at the gates, nothing will help. Short of that, my guess is that the U.S. government and Apple computer (along with a lot of other cash heavy companies) aren’t going bust anytime soon.

Unfortunately, what’s good for the individual bill payer and investor isn’t exactly what’s good for the economy right now, but do it anyway. Economists want us to spend right now. But in periods of uncertainty, individuals paying individual bills need to cut those and hang on to their dough. So probably you should put off the world tour, the brand new car, or the McMansion purchase for now, unless the family chariot is up on blocks.

Don’t sell your investments and go to cash. In fact, put any investment cash into whatever part of your asset allocation is doing the WORST, that’s called rebalancing or buying LOW, which is what you’re supposed to be doing, right?

I don’t recommend any significant investment in individual stocks in a prudent investment plan, but I know some of you like to dabble anyway (okay, I do too, but only a little). If you’re going to do this, I highly recommend Better Investing’s recommended methods of evaluating investments (they used to be NAIC–National Association of Investment Clubs) and if you follow it, you already have a wish list of stocks you’d like to own. Well, take a look–maybe they’re “on sale” right now.

That’s really it–sit tight, turn off the tube, get off the internet, and try to calm down. With a decent asset allocation plan, you’ve done all you can to influence the universe. And if you don’t have a plan, well, ahem, you need a financial planner. I’ll look forward to hearing from you. But take a deep breath, okay?

Investments—eat what you cook

Financial advisors are really good at cooking up investment schemes. I’ve seen stews made up from crazy lists of gold, commodities, all cash, pink-sheet stocks—you name it, some advisor, somewhere, is recommending it as the only way to go. So, may I recommend you choose something other than the plat du jour? Try asking your advisor how much of his or her personal money is invested in the recommendation.

For mutual funds, this information should be in a Statement of Additional Information, usually grouped with the prospectus literature on an investment company’s website. From my point of view, it’s most interesting to know this information for actively managed funds. For index funds, it doesn’t much matter as the manager is making far fewer decisions. Their responsibility is to track their benchmark, not season the sauce. However, a manager that purports some strategy that claims to beat the market ought to sit down at the table and take a big gulp, and I’m not talking about a $10,000 investment, which is barely a tip to these guys. If he’s heading for the exit, he probably knows something you don’t (and should). Me, I’m LOTS more interested in investments I actually have money in, although some of them, some of the time, require a Pepto to stomach.

Now let’s take a look at those “investment advisors” who call you up with the latest hot high-commission sales product their firm is pushing—e-r-r-r, considered investment recommendation. I think it’s entirely legit to ask whether they’ve bought the product themselves, and if so, how much or what portion of their investment portfolio is placed in that investment? Of course, it’s always possible that the investment may not be “appropriate” for their personal portfolio, but I’d sure want to know why not. If they’re not willing to take the risk, why should you?

There is one big “but”, however. You don’t want someone who’s made a huge buy, decides to pump you up, then sell his own holdings at the now inflated price. That is, unless you enjoy seeing your “investment advisor” doing a perp walk in a photo in the Wall Street Journal.

You can’t protect yourself against every possible misstep, but these ingredients can go a long way:

1. Know how much you’re paying and how you’re paying it. Nobody works for free. There’s ALWAYS a fee or commission or hourly rate somewhere in EVERY investment.

2. Find out whether the advisor invests in the recommended investment.

3. If it sounds too good to be true, IT IS. This one principle alone would have saved all the Bernie Madoff victims and most of the victims of rip-off mortgage loans.

4. Just because someone’s nice doesn’t mean they’re good. Personal charm of the broker has nothing to do with the worth of the investment.

 Check it out before you fork over your money. Bon appétit!