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After looking over the responses to yesterday's post, my new working theory is that the subprime mess can be boiled down to a widespread failure to follow the most basic rule of investing: diversify.

That's true whether we are talking about the widow, or the pension funds, or the banks, or any other corporate entities that held these exotic mortgage backed securities. If they got in trouble, it is only because they put too many eggs in one basket.

Apparently lots of people bet their corporate and/or corporeal lives on these unfathomable investments. You might be making the same sort of mistake right now, but in a different way.

I know people who use financial advisors to help them spread their money across many different financial investments. This feels like diversification, but it isn't. If the financial advisor is a crook, or incompetent, you put all of your eggs in one rotten basket. In the case of the widow who was convinced by her financial advisor to put a lot of money in these exotic securities, the problem was the advisor more than the securities.

When I first started making serious Dilbert money, I let experts manage half of it, and I managed the rest, as a hedge against both the experts and myself. The experts invested in Enron, Worldcom, and a number of other companies that promptly exploded. The experts reduced their portion of my money by about a third over five years. (The experts work for one of the most respected financial institutions on Earth, by the way.) My own investments did better, precisely because they were more diversified. So now I handle my own investments, probably incompetently.

I didn't own much in the way of stocks for the past several years, thanks to not using professional advisors. A big chunk of my money has been in California Municipal bonds of various types, and all are insured. When I asked my bond advisor what good it would be to have insurance if the entire state of California goes to hell, they advised me emphatically, and obviously incorrectly, that these big insurance companies are ready to take any hit.

In order to diversify more, I started migrating money over to the stock market during this recent plunge. The market could go a lot lower still, but this is either the beginning of the end of the United States as we know it, in which case it doesn't matter how I invested, or it is a once-in-a-lifetime stock buying opportunity. It was an easy decision.

Are you diversified?
 
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Oct 15, 2008
"If you invest with the idea that you will become wealthy from your investments, diversification guarantees that you will never become wealthy. However, if you invest to preserve your wealth, diversification is key. A well diversified portfolio seeks to eliminate risk or at least minimize it, thus preserving wealth, not creating it."

There is an element of truth to this, I suppose, but with one big problem - individual stocks are way, way riskier than mutual funds or other diversified investments. Diversification does guarantee that you won't become hideously wealthy thanks to a lucky hit with your portfolio (buying Microsoft at its IPO or something), but it also virtually eliminates the risk that someone pulling an Enron wipes out your entire savings while (at least historically, over time) growing at a greater rate than inflation.

Basically, if your idea is to roll the dice and see if you can hit a jackpot, fine, throw your money at individual stocks. If you are investing your money for the sake of growing it for eventual retirement (or saving for some other long-term goal), a diversified portfolio is, by far, a better bet.
 
 
+1 Rank Up Rank Down
Oct 15, 2008
There is another good use for money in down times, spend it! Particularly if you fear inflation.

I'm not saying spend all your money on !$%*!$ and coke here (well, not all of it). I'm thinking why not buy today what you are hoping to buy in several years if you have the cash (when it will be more expensive due to inflation). I pre-pay my kids college credits, which I figure is better than investing money for 10 years and hoping that it works out OK by the time I need the cash. I am planning some minor house renovations that I had planned to put off (with the added bonus of getting good deals from contractors who all need work now!).

If I could buy 10 years of pasta and dish washing detergent today and put it somewhere I would... It's just going to get more expensive over the next couple of years while my "investments" will probably do nothing positive.

Luke
 
 
Oct 15, 2008
When the market is down the way that it is now, wise investors consider it a "yard sale" . . . the yard sale where you find the Van Gogh behind a black velvet poster of Elvis.

Now is definitely the time to buy - as long as you don't expect an immediate return on your investment.

As the Great Depression started to ease a little, my great-uncle invested heavily in blue chip stocks and just let the money sit - no moving to this stock and that one. When he passed away and the estate was liquidated, he was worth over $15 million.

Not bad for a yard sale.
 
 
Oct 15, 2008
Smart move Scott. People here at work keep wondering if their retirement investments will be okay with the market turmoil. I ask them if they are continually contributing like I am to buy more stock while they are low, so when the market balances, and they go back up, you will have a lot more than you did before the slump. They don't feel so bad after that. I have my investments split into quarters, three of those are managed by three different firms, all of them doing fairly well, and the fourth I play with myself. I don't claim to know more than the investment companies, I just like to feel like I have a hands on my money, and I can play and know that most of my investments are safe. I am not looking to become wealthy, I just want to enjoy my retirement at 55 and not have to worry about money.
 
 
-1 Rank Up Rank Down
Oct 15, 2008
kalirion - The point is the same, if all of your eggs were in one basket, albeit a insanely successful basket, you are a member of an elite club that spells the numerical value of their net worth beginning with a B.

If you want to maintain and grow your wealth more modestly, diversify across many baskets.

 
 
Oct 15, 2008
[If you seek to create wealth from investing, concentration is the ONLY path to success. Consider any successful company start up (Microsoft, Apple, Amazon, EBay, etc. etc.) - I don't believe any of them became extremely wealthy because they spent time diversifying their company.]

phb, I think you lost your train of thought somewhere. These "successful company start ups" did not become wealthy by investing in stocks...... People got wealthy by investing in these start ups, not the other way around.
 
 
Oct 15, 2008
I personally always thought a "financial advisor" was a paradox position. If they were good enough to make a good return in the market, surely they wouldn't need that moderately-paid position (I'm excluding the big fund managers and the like).

Do you apply this concept of diversification to your investment in the (potential) afterlife? It would stand to reason, that for someone to have the bets opportunity for an afterlife (assuming there is one) they should diversify their religions. I suppose you could pray to many different gods, attend several different churches, etc. Of course that all depend on whether or not any of the deities you pray are the jealous type.
 
 
+1 Rank Up Rank Down
Oct 15, 2008
I'm a huge fan of diversification for assets. For the record I don't have "serious money" but what I do have I try to spread around with the hope that not everything will tank at once. For example my husband and I both have 401Ks and mine is more risk oriented (and probably trashed, I shudder to think) and his is more security oriented. Next we have some invested in real estate (our house) we keep enough there to not have to pay mortgage insurance, but not enough that if the real estate market crashes *ahem* that we will be out on the street. We also always live on acreage and that seems to hold value better than average neighborhoods. I'm not working at the moment, but when I do work my husband and I try never to work for the same company or companies in the same industry. We outfitted part of our house as a mother in law apartment and we rent that out for enough that we can do improvements to our property and support my equestrian habit. Additionally we try to manage what debt we have effectively and to keep all revolving credit paid off. At the moment we owe on our house and one car (only because one recently died). We save for almost everything we buy and we keep keep money in two different financial institutions.
 
 
Oct 15, 2008

First, it's called "rebalancing."

it means you should have an allocation of the diveristy in mind (e.g 20% in this kind of thing, 25% in that kind of thing, 45% over there and 10% here.) and try to keep it there.

You see, as some investment (areas) do better and some do worse -- and this will happen -- your allocations will get screwed up. So, every so often (every year? every six months?) you need to fix them. This words against some human insticts because it forces you to sell some of what is doing well and buy some of what is doing poorly.

However, that means that you are buying low and selling high.

Do this automatically, and you come out ahead. It means that you take advantages of some of the little fluxuations, and even some of the big ones, too. Doing it automatically prevents crappy human instict from preventing you from doing the wrong thing, as in "It's shiny! I don't want to let it go."

***************************************

The other part of the the question is how diverse you want to be?

A) There's lot of kinds of Protestant. And there are even more kinds of Christian. And there are even more relgions of the book. And even more religions, total.

B) There are domestic stocks. There are international stocks, too. There are government bonds, and corporate bonds.

Almost every every US president as been nominally Protestent. One Catholic. We are not even ready to have a Muslim president, perhaps not even a Jewish president, and certainly not one who believes in many different gods. There are degrees of tolerance/diveristy.

So, the question is not whether or not your are diversified, but rather of how diversified you are. And I don't know what the right degree is.
 
 
+1 Rank Up Rank Down
Oct 15, 2008
you are right, diversification is the answer. When I sold my house I had a small chunk of change that needed a home. My advisor wanted a lot more involvment in mutual funds but I took about 1/2 of my money and put it into an ING cd. I have a very low tolerance for risk. That turned out to be a good choice. my CD made more money than my mutual funds. An advisor should be more of a source of information so that you can make informed choices that are good for you
 
 
Oct 15, 2008
I think diversity is the problem yes, but in this case I think the problem was the the insurance policies on the defaults of this loan. In this case you had people buying contracts which agreed to pay multiples of the actual loan value if the loan was defaulted on, in other words people were allowed to insure more than the value of the loans. This amplified the amount of risk associated with these loans and lowered the total diversification. Just like you can't take out an insurance policy for $100K on your $5K corolla, you shouldn't be able to do this kind of credit insurance.
 
 
Oct 15, 2008
Another couple of things: don't confuse volatility with risk. Investments gain and investments lose, but over time, they always (or have always) gone up. The analogy is a person walking up a hill while using a yo-yo, the yo-yo being the level of your investment at any point in time. While at any time, your investment may be up or down compared with where it was the moment before, over time it always goes up. As long as you are properly diversified.

Concentration in any single asset class is a way to go broke, because your emotions take over, and you tend to buy high and sell low. You ride, for example, tech stocks, buying in when they're pretty high because they're going up. Then, the bottom drops out, and you sell low because you panic. Emotion will kill you in investing.

Putting your money into CDs or Treasuries appears safe, but the problem is the return is too low. It rarely keeps up with inflation, and almost never exceeds it. That means over time that you are going broke safely. Your money is losing buying power while being really safe. You lose.

Sure, you can get lucky, pick a single stock, buy low and sell high. You can also go to Las Vegas and hit a jackpot. But can you do that every time? If you can't, you're going to get hosed, because again emotions will take over and you'll make a bad decision that can wipe you out.

At least consider the diversification approach. Through compounding, over time, you will become wealthy, while minimizing your risk. Not a bad thing to consider.
 
 
Oct 15, 2008
Yes and no, to your question. I have recently become diversified in about half of my investments. My investment advisor is a member of the Ric Edelman financial company. Ric is big on diversification - my investments are spread across 19 asset classes. If you're interested in his methods, go to www.ricedelman.com.

When you're there, you can go through an exercise that evaluates your risk tolerance, timeframe and goals, and then see what kind of portfolio Ric would recommend. No obligation, and no advisor will call you unless you request it. You can also call his firm at 1-888-PLAN RIC, and one of his advisors will review your portfolio and make recommendations, all at no charge.

This is not meant to be an advertisement for Ric Edelman, although I think he's the best there is. There are a lot of good fee-based advisors (don't go with one who is commission-based, or over-leveraged in one asset class, such as stocks). If you want a local advisor, call the above number and they'll give you a local firm that follows the same philosophy.

If you think it's a good philosophy, go with it. The reason I mention Ric's firm is that he has written some good books that make sense, and in listening to him on the radio for the past two years, I have come to learn a lot at no cost to me. His firm will talk to anyone and give advice, and will do it without charge or obligation. He also has a nation-wide radio show on the ABC network - here in the Bay Area, it's on KSFO 560 from 10 AM to noon on Saturday.

Ric's most recent book, where he (among many other things) goes through the same portfolio evaluation he does on his web site, is titled "The Lies About Money." Well worth reading - if you don't want to buy it, check it out from the library.

The rest of my net worth (about 2/3) is tied up in real estate. Prices are down now, so on paper we've had a loss, but you don't really get a loss or gain until you sell, and you don't pay taxes on any gain until you sell, either. Also, a reduction in value means a reduction in property taxes - YAY! However, we did manage to sell one property at the top of the market and roll the gain into another property. The equivalent property is selling now for about half what we sold it for, so that's goodness. All our properties, save one, are worth more than we paid for them, so we're well ahead - but most of them are long-term holdings (the other secret to successful investing - invest for the long term, and compounding will make you wealthy).

In general, there are two ways to invest your money: investing or speculating. Day traders and people who chase today's "hot" stock are speculators, and they get hammered with great regularity. A properly diversified portfolio with certain hedges (gold funds, real estate, etc.) will help you build wealth, long term. That's Ric's message, and mine as well.

You were wise to move money into stocks at the low - but the question is, is your portfolio balanced? Chasing gains are swell, if you are properly invested across asset classes - it has to do with minimizing risks while getting higher than average returns. In my case, Ric's firm kept my portfolio balanced by selling bond funds while buying stock funds - the goal being to keep the percentage (dollar value) of each asset class the same. When you are properly diversified and believe your asset allocation is correct, then your goal is to maintain that asset allocation. This means selling what has done well to buy what has not done well, which at first glance sounds contrarian - but if you think about it for a while, you'll see the wisdom of that approach. If you don't, go on Ric's web site or read his books, and at least you'll gain an understanding of how this approach works and what its goals are.

The other advantage to going with a firm like Ric's is that he has access to investment classes that the average investor doesn't - things like ETF's and Institutional funds. You can tag along to some very large funds that you could never invest into on your own.

At the very least, taking a look at something like this will expand your knowledge, and possibly help you make some decisions about your future asset allocations. Couldn't hurt.
 
 
Oct 15, 2008
Yup, I'm diversified. I had the good fortune to come into a large sum of money in March this year. I used some of it to buy a boat, a car, some land and invested the rest with the help of my experts in a diversified portfolio of mutual funds. The boat, car and land are all still the same size. The investment portfolio, however, has shrunk quite a bit. I thought I was buying at a good price last April and I still think that price will look good a few years down the road, but it has obviously gotten a lot better since then. My experts have done well for me over the past 13 years with retirement savings, generally beating market indeces.

If things don't turn out the way I think they will and it is the beginning of the end, I will still have acreage on which to grow and shoot food.
 
 
+2 Rank Up Rank Down
Oct 15, 2008
Scott,

If you invest with the idea that you will become wealthy from your investments, diversification guarantees that you will never become wealthy. However, if you invest to preserve your wealth, diversification is key. A well diversified portfolio seeks to eliminate risk or at least minimize it, thus preserving wealth, not creating it.

If you seek to create wealth from investing, concentration is the ONLY path to success. Consider any successful company start up (Microsoft, Apple, Amazon, EBay, etc. etc.) - I don't believe any of them became extremely wealthy because they spent time diversifying their company.

Also, if you consider where your wealth was generated, I am sure you will agree that it was created because you spent focused, concentrated creativity on your craft. I further suspect that your greatest drains of wealth came from areas or attempts to "diversify" your attention (ie restaurant business).

You were wise to fire your money managers who exposed you to the risk of an Enron, Worldcom, et al, but do not forget that their job is to remain hired and if they had scored big by risking your money, you would be very happy today. So, think about the risk you are taking today by exposing your wealth to uncalculated risk of buying into a market trend that NO ONE quite understands. Do yourself a favor and stick to cash or gold or munis (assuming you can calculate the risk involved with owning a bond by a government!).

Good luck!
 
 
Oct 15, 2008
"financial advisors" are just about as useful to most of us as real estate agents and screen doors on submarines. they are a genera of parasitic lifeforms with just about as much capacity for independent thought as nazgul. grrrrr...
 
 
 
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