Investing: Why You Should Diversify

Updated : Sep 10, 2019 in Articles

Investing: Why You Should Diversify


♪ [music] ♪ [Alex] In previous videos,
we’ve hopefully convinced you what you shouldnotdo. Don’t try to beat the market
by picking stocks. And definitely,
don’t pay someone big money to help you pick stocks. Now let’s turn to a rule
that tells you what you should do. Investment Rule #3:
Diversify! Diversify! Diversify! And, choose funds with low fees. Diversification allows you
to reduce your risk by spreading your investment
across many different assets. The great thing
about diversification — it’s a free lunch. It reduces your risk
without reducing your return. Don’t put all your eggs
in one basket. I’m sure you’ve heard
that saying before. Yet when Enron —
one of the most successful and seemingly safe energy giants —
when it collapsed, its employees had about 60%
of their retirement savings in Enron’s stock. Many employees
who once had been millionaires — they retired with next to nothing. So let’s be clear:
it may sound loyal, but investing in the stock
of your employer — it’s never a good idea. Two reasons:
First, you should never have a substantial fraction
of your wealth in a single asset, whether it’s
your employer’s stock or not. Second, investing
in your own employer really does put all your eggs
in one basket. If the company goes down,
you lose your job and your retirement savings
at the same time. Terrible idea! Moreover, modern financial markets
make it easy to diversify. Our favorite investment
is index funds — low fee funds that simply mimic
a large market basket, like the S&P 500
or the Wilshire 5000. But don’t limit
your diversification to stocks from your home country. That’s called home market bias. It’s quite easy
to diversify internationally by buying
an international index fund or by buying more
big multinational companies. Once again,
diversification is a free lunch. By diversifying,
you can lower your risk without reducing your return. Since stock picking doesn’t work, you shouldn’t pay someone
to pick stocks for you. We’ve said that already. And we’ve said that
our favorite investment device is a low-cost index fund. But, even among index funds,
some have higher fees than others. So look for funds with low fees. Vanguard often has
lots of good choices of low-fee index funds. But in any case,
make sure you check. Fees might not seem
like a big deal, but they’re one of those things
that adds up over time. If you invest $10,000 today,
for example, and you hold it in a mutual fund
that charges 1% fees annually, then in 25 years,
you’ll have about $57,000, assuming a market return of 8%. Fifty-seven thousand —
that’s not bad. But if you invest
the same $10,000 dollars in an index fund
that charges 0.2% in fees, a very reasonable number, then in 25 years, you’ll retire with just over
$70,000 dollars. Do you really want to give up
nearly $13,000 — for nothing? The bottom line is
that when it comes to investing, simple is the way to go. If your employer offers
a 401(k) plan, sign up. Invest a constant fraction
of your paycheck regularly and put the money in a
low-cost index fund. I know there’s a few
sophisticated folks out there who — maybe they’re
not yet convinced. Maybe your friend advised you
to buy stocks in December to catch the January effect. Or they told you that stock prices
fall on Mondays. Maybe you’ve heard that people
aren’t perfectly rational and that the market
is filled with anomalies that efficient markets theory
has trouble explaining. Next up, we’re going to dive
into the findings of behavioral finance to see
whether we can profit from irrational behavior
and market anomalies. [Narrator] Check out
our practice questions to test your money skills. Next up, Tyler covers how markets
sometimes misbehave. ♪ [music] ♪

15 Comments

  • One form of diversification is by tax structure: Traditional 401k/IRA vs the Roth variety vs. Taxable. While I agree that company stock should not be included in tax protected accounts, I do believe such a holding has a place in a Taxable account. I'm specifically referring to ESPP. These have a build in 15% advantage at purchase ( at either the start or end of the subject quarter, whichever is lower) and are a good avenue for harvesting tax losses to offset capital gains from other taxable holdings.
    No need to go nuts on these, but they are a perk that is often ignored.

  • i didn't get the first questing.

    Oil firm, Airline firm or Solar firm.

    choose any 2 for investment Diversification strategy?

  • Completely wrong!

    While it's true that it's not reasonably possible to get rich quick in the stock market, it is extraordinarily easy to beat the market.

    The secret is to buy dividend stocks and/or share buy-back stocks during market corrections, while avoiding obvious losers that have major financial problems.

    You won't get rich quick with this strategy, and you will have losers from time to time, and you will occasionally not beat the market. But the gains over 30 years will be at least triple the gains produced by the market/index funds.

  • You say that there is no cost to diversifying, but doesn't diversifying mean that there is less chance of my investment growing at an unusually high rate?

  • ive invested in property thus far…but I'm worried about interest rates going up,,,so I might just pay off my mortgage then buy some stocks next

  • Not sure that I agree with the "never" invest in your own company's stock.   Many companies offer a discount in buying stock.  If that's the case, it might make sense to buy at the discount, since it's basically subsidized.   That said, your point was having too many resources tied to a single institution (job and savings).   At that point, it make sense to transfer those assets elsewhere, when possible, in order to increase your portfolio's diversity.

  • the index fund example with the 1% MER vs 0.2% MER was calculated for 26 years and not 25 years? Or am I just high

Leave a Reply

Your email address will not be published. Required fields are marked *