The Importance of Diversification

Ever hear the story of the guy who was rich one day and homeless the next? He wasn't diversified. Just talk to all the former millionaires that invested only in tech stocks around 1998 and boasted about their wealth before they watched it go to $0. You might think this is uncommon, but it happens more often than you might think. Madoff and others convinced people to give them all their retirement savings and promised them unbelievable returns only to lose it all. Others put everything into Enron stock thinking it couldn't go down only to lose it all. I hear too many of these stories! Diversifying is so crucial; whether you're dealing with individual stocks or your total investment portfolio, this is something you need to know. If you're going to trade the stock market on your own and not use mutual funds, then make sure you are diversified and never put all your investment money in just stocks.

What does diversification look like? Well, if you're trading stocks on your own, you want at least 5 stocks, and they should all be from different industries. For example one tech, one retail, one financial, one home builder and one healthcare stock. There are multiple variations; this is just one example. Don't put all your eggs in one basket, ever, no excuses. A stock portfolio with Wal-mart, Boeing, Cisco, Pfizer and Goldman Sachs is diversified. A stock portfolio with Target, Best Buy, Apple, Google and Cisco is not; too many similar industries (retail and tech). If both industries go into a downturn, your portfolio will feel the pain. With diversification you can better protect yourself from total destruction. It's unusual for every industry to collapse simultaneously and this reality helps to limit your losses. In a broader sense it's a good idea to be diversified too. You should own some real estate, stocks, rare coins, tax liens and also use extra cash to pay down debt, save on interest payments and increase equity in your assets. Diversification is the way to a more successful and stable financial future. Remember that most people have too much exposure to stocks and real estate. This is because of 401(k) investment choices typically limit you to stock, bond and REIT investments. Also, for people that are homeowners, your primary residence counts in the real estate investment class.