How And Why Should I Diversify?

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How And Why Should I Diversify simple money man

 

You don’t want to eat the same food every day right? You don’t want to wear the same shirt, shoes, socks, underwear (hope not), everyday right? You don’t want to want to watch the same episode of Seinfeld everyday right (even though I myself love “The Summer of George” and am smiling as I’m writing this)? Each one of these actions has negative effects.

 

Do you know what happens when you eat too much broccoli? None may be especially life-threatening, effects can include gas, irritable bowel (especially important for pregnant women), reduction of blood sugar levels (important for diabetic patients), and thyroid underperformance. Many sources say to make sure you include broccoli in your diet but in moderation.

 

They say variety is the spice of life. If you eat the exact same thing all the time, your body will be negatively affected. Just take a look at that guy who experimented with eating McDonald’s for a month.

 

And if you invest in just one thing, your investments will be negatively affected.

 

 

Inefficient Strategy – Lacked Diversification

 

Admittedly I was severely under-diversified early in my investment career. One of my strategies was to simply find out when a company is about to announce its earnings, see if it’s expected to beat earnings per share based on market estimates and buy some shares a few days before. Then I would sell a few months later, usually with a small gain, but that gain would be reduced due to short-term capital gain tax.

 

Apart from being under-diversified in practically all sectors, it wasn’t an inefficient strategy, required too much monitoring, costs too much and, not sustainable for the long-term.

 

I also found myself in situations of missed opportunities. There were investments out there that would allow me to diversify at a low price, but I was over-concentrated in certain investments and was not in a favorable position to sell. But that’s a different story for another time.

 

 

So Easy To Diversify

 

You really can diversify by just buying into a fund. For example, if you want to diversify into the S&P 500, the Vanguard Total Stock Market ETF – VTI may be an option.

 

Years ago, investors needed lots of money to buy different types of stocks and bonds to be properly diversified into the market. And not too long ago, there were investments minimums (i.e., $5,000 or $10,000) to get into a mutual fund.

 

But with an ETF, there is no minimum. We are all able to enjoy the benefits of diversification – one of which is the ability to sleep better at night.  🙂

 

Even when you are nearing retirement, it’s important to maintain diversification and balance. You don’t want your investments to be so conservative that they are not beating inflation. Otherwise, you may run the risk of not having enough during your retirement years.

 

A balanced fund could be an option. For example, the iShares Core Moderate Allocation ETF was noted by U.S. News as one of the Best ETFs in the 30% to 50% Equity Allocation. Per its website, it has a fair balance of Fixed Income and Equity Assets:

 

How And Or Why Should I Diversify AOM allocation simple money man

 

 

When you drill down a bit more, the iShares Core Moderate Allocation ETF diversified into the international sector as well so it’s got that covered too (the 3rd fund in the list – IDEV):

 

How And Or Why Should I Diversify AOM top 10 simple money man

 

So Dangerous When You Don’t Diversify

 

To make it plain and simple, the dangers of diversifying include, but are not limited to the following:

 

  • Retirement Income Risk: You’re nearing or are in retirement and don’t have any money invested in bonds. The stock market has tanked and you have suffered major unrealized losses in equities. You could have avoided this by diversifying into bonds and continuing to manage your allocation so you could enjoy the comfort of a steady income stream and lock in gains from equities when their valuations were high.

 

  • Industry Risk: Your money is tied up in one industry (e.g., financial sector). And when the technology sector starts its rapid rise, you are unable to seize that opportunity because your holdings in the financial sector are in a position that if you sell, you will suffer a great loss.

 

  • Loyalty Risk: You’ve contributed and therefore invested a significant amount of money in your organizaion’s employee stock purchase program (ESPP). Your organization is suffering major losses in revenue, resulting in layoffs and ultimately significant reduction in its stock price. You could diversify by investing only some money in your organization’s ESPP and most of your paycheck contribution towards a diversified ETF.

 

 

Learn To Diversify From The Best

 

Here are the top 5 positions in Warren Buffett’s portfolio:

How And Why Should I Diversify simple money man buffett portfolio

 

As you can see, they are all established comapnes and of different sectors. We have in his list of top five companies, which represents almost 65% of his entire portfolio the sectors of Technology, Financial Services, and Consumer Staples.  Many of us have heard the positive things he has said about Coca-Cola. This just proves that he is not concentrated on a single stock and maintains a diversified portfolio.

 

To make sure he continues to be diversified, Mr. Buffett has mentioned that he would like his wealth to be moved into Vanguard’s low-cost index funds for his wife after his passing.

 

You’ve probably heard the metaphor that diversifying means not putting all of you eggs in one basket. Your eggs are your money and the basket is an investment. Your eggs are not all of the same sizes. That is, you don’t want $500 each in 5 different sectors.  Instead, take your various egg sizes (e.g., Medium, Large, Extra-Large, Jumbo) and decide which baskets you want to invest in to give yourself diversity and protection against losses.

 

Please note that diversification itself does not guarantee against losses. But oh boy, it does it help you a lot to avoid losses!

 

 

Join The Discussion:

  1. How well are you diversified? Is there any area you need to balance off?
  2. How often do you rebalance your assets to ensure proper diversification?
  3. Have you suffered losses in the past due to lack of diversification?

 

 

Disclaimer: Please note the funds mentioned are for example purposes only. I do not support nor oppose them in any way. Please make sure you perform due diligence and consult with an investment advisor before making investment decisions.

 

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I use Personal Capital because (1) it’s free, (2) it tracks all of my accounts and overall net worth, (3) my account balances automatically update, (4) it shows how my investments are diversified and allocated in various sectors, and (5) can use built-in tools like “Investment Checkup” to get….wait for it…free personalized advice!

 

 

8 thoughts on “How And Why Should I Diversify?

  1. Hey SMM,

    I’ve learned to be diversified. For our retirement accounts, it’s all in diversified lifecycle funds. For other accounts, it’s still diversified, but I trade a bit more actively (mainly because I enjoy it). We’ve even got some crypto 🙂

    Cheers,
    Miguel

  2. Big believer in diversification here SMM. Many great investors will argue that diversification only limits your gains. But I would rather limit my gains and protect my downside through diversification. Tom
    Tom recently posted…Financial Independence DayMy Profile

  3. we have this: 14% intl. index, 12% mid cap index, 5% reit index, 8% sm cap index, 1% sp500 index, 15% preferred indices (bond proxy), 42% individual stocks with no more and 13% of that in one name. the top 11 stocks make up about 73% of the portfolio. we have no banks, no energy plays, except in those indices. i stopped dividend reinvestment to look for the best opportunities with those dividends. oh, and if you’re adding at home, we have 3% cash.
    freddy smidlap recently posted…Good Eats for Cheap #2 – Grilled Cabbage SaladMy Profile

  4. I have been diversified from day 1. At least from the day I started index investing. It’s really easy given that I own ETFs. My portfolio is well diversified. Its a little low on bonds. I use cash to compensate for my fixed assets. I don’t re-balance much. I pretty much my AA for new funds to compensate for allocation creep. This is easier when the portfolio is smaller in size. When I started out investing I did lose money … you could say my portfolio lacked diversification. It was made up of speculative stocks.

    1. Sounds pretty familiar to my situation from my earlier days of single stock investing and, yes speculative position. I’m in the ETF game too and it has everything you need in terms of diversification. You buy a couple of them and you are good! 🙂

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