One of the most important parts of investing is the practice of diversification and having a diversification strategy. I can remember my college professor saying: “Don’t put all your eggs in one basket.” Now I could say I’ve heard and repeated that saying over a million times myself. But why? Why not put everything on that one single penny stock that could potentially double overnight? Why not put everything in McDonald’s, for example — who not only pays a dividend, has never missed paying a dividend and annually increases their dividend as far back as the eye can see? The answer is: risk. The same reason you shouldn’t only eat McDonalds every meal, every day. You must learn to diversify.
How CrossFit demonstrates the benefits of diversification
A great example to show this concept is one of the latest fitness trends: CrossFit. It’s a combination of just about ALL fitness styles combined: Olympic lifting, running, mobility training, cross training, gymnastics, yoga and more. It’s a diversified fitness program, which can give your body the best of everything. One of the main goals of CrossFit is to prevent your body from hitting a “plateau.” But you must keep your investment portfolio healthy too – this concept applies to your finances in much the same way.
Reasons to keep your investments diversified
- It’s EXTREMELY difficult to know which investments are going to perform best: Even today’s top economists get their market predictions wrong on a regular basis, in fact.
- You always want something in your portfolio to be in favor — no matter what’s going on in the market. This allows the “in-favor” assets to soften the blow when other assets are out of favor. An example: If you own only airline companies in your portfolio, and one day all pilots announce they are going on strike, flights get cancelled and so on. You could potentially take a serious loss. However, if you had ½ your investments in railroad companies, chances are railroad stocks would rise because people would see it as an alternate form of transportation.
- Diversification enables rebalancing. Naturally, our tendency is to add new funds to the investments that are doing well. If you add money to those, you will likely buy at the top of the market. Its better to keep your contributions mixed.
There will always be risk, but you can manage it with a diversification strategy
Diversification can help an investor manage risk, reduce the volatility of an investment’s price movements, and give exposure to alternative investments – all great things. Just remember that investment risk can never be eliminated completely, it can only be managed properly. From the physical fitness angle: you can diversify your McDonald’s only diet to Wendy’s and Burger King instead… but it doesn’t reduce your chances of heart disease unless you add mixed greens and veggies. The key is to find a happy medium between risk and return and a good mix of asset classes; and a financial advisor can help. This will put you on a path to achieving your personal and financial goals and maximizing value from your hard work both in the gym and in your portfolio.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. No strategy assures success or protects against loss. Investing involves risk including loss of principal. The payment of dividends is not guaranteed. A company may reduce or eliminate a dividend at any time.