Diversify Your Investments. No, Really, We Mean It

by Lee Distad

Eggs, Cash in a Basket

Diversifying your portfolio is one of the most fundamental pieces of an investment strategy. It’s essentially the old aphorism that says you shouldn’t put all your eggs in one basket.

The underlying motive for diversification is to reduce risk: by having your investments spread between different funds, equities, or financial instruments, your portfolio is less exposed to the downside risk of any one of your investments.

Put like that, it makes sense. But how many of us are really diversified? I’m reminded of the old joke from the Dot-com era where a man who’s been told to diversify his holdings replies, “Of course I’m diversified, I’ve got Microsoft and Intel!”

Are All Your Eggs in One Basket?

There are even people who counsel against diversifying at all, and think that investors should put it all on one number and let it ride.

In his book A Gift to My Children: A Father’s Lessons for Life and Investing, billionaire Jim Rogers writes: “Bill Gates didn’t diversify. The way to get rich is to put your eggs in one basket, but watch that basket very carefully. And make sure you have the right basket. You can go broke diversifying. Ask anyone who’s diversified in the last three years. They’ve lost money.”

But picking the right basket is the trick, right? Satirical website Long Or Short Capital parodied that mindset when they posted their Four Simple Steps To Becoming A Billionaire:

  1. Take outrageous risks with extremely high upside.
  2. Be the 1 out of 500 million for whom it pans out. This one is key so focus on it.
  3. Attribute your wealth creation to your own hard work, your own genius and the power of your business plan. Be sure to stress how your wealth was singularly made possible by your unique endowment of elbow grease, street smarts, common sense, all of which your competitors obviously lacked (proven by how poor they are compared to you).
  4. Buy a mega yacht and/or athletic team.

You need to remember that diversification isn’t so much about creating wealth as it is preserving wealth. It’s risk reduction, in short. It’s no coincidence that risk reduction is also a main goal of the long-term, value-oriented approach to investing that Automatic Finances recommends.

Even Index Funds Need Some Diversification

If you primarily invest in exchange traded funds or index funds, how much more diversified could you be?

That’s already a great start. Just ensure that you spread your baskets of eggs out far enough from each other. That could mean any number of choices, such as a diverse group of index funds in disparate sectors, balanced with some fixed-income securities. The details are ultimately your responsibility.

As always, do your due diligence and stick with it for the long haul.

About the author: Lee Distad consults with CE integration firms on design, installation and project management processes and Best Practices, and offers provides professional copy writing services for websites, brochures, and marketing initiatives. Visit him at www.leedistad.com.

{ 1 comment… read it below or add one }

Sriraksha Financial Planning Services October 31, 2012 at 2:59 am

Nice post. Effective Diversification is all about investing in different asset classes which are not positively co-related. This would ensure that you will never end up with a situation where all your investments under-perform at the same time

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