Thanksgiving means fall’s in full swing. The air’s cooler and the colorful foliage has come and gone. Like seasons changing, the markets and economy have been undergoing massive changes, making this a great time to review some basics.
By basics, we mean diversification at the simplest level, and how to use it. My intent is to give you something to use immediately to give your portfolio a pulse check.
What is diversification? For some, it’s having your money at different places, i.e. having some money at bank ABC, bank DEF, and investments at firm HIJ. For others, it’s having a few different advisors managing their assets.
Webster’s online definition is “to produce variety,” “give variety to,” or “to balance.” In relation to a portfolio, it’s having money spread among different sectors and industries. The S&P; 500 has 10 different sectors that are all different sizes. Having money split among these areas helps reduce the overall risk of your portfolio.
Some individuals become attached to company stock or one particular sector because it’s what they know. It’s easy to do. Just think about your current job. If required, would it be easier for you to find another job in the same industry or in a new industry you know nothing about? Many follow this approach when investing, particularly those who invest heavily in company stock within their work retirement program. Earlier this year, Workforce.com noted that 42 percent of the top 65 corporate defined-contribution plans have at least 25 percent of their 401k assets in company stock.
A few years ago, that may not have seemed like a large risk. This year is a different story. If you’re one of these individuals, stop and think about if your company became the next Lehman, Merrill, Bear Stearns, Freddie Mac, Washington Mutual or AIG. Many of you may be thinking, “All of those companies are financial institutions.” Correct. But look at how easily things could affect your company.
I think everyone will agree there’s a credit crunch right now. Banks are sitting on a bunch of cash, and there isn’t much trust. Everyone’s worried about return of principal instead of return on principal. A large amount of our economy’s past success comes from the fact that we can borrow money to grow. This helps fund capital, day-to-day expenses, and even payroll occasionally. Now imagine the funding tap gets clogged and the project your company was counting on for growth has stopped because they cannot get the capital to push forward. This can have an adverse effect on the stock price, and consequently your investment.
The point of diversification is to help manage things like this by spreading your money over several different sectors and compa nies. It also helps put the pieces together with “Know what you own, why you own it, and how you plan to use it.”
Joseph “Big Joe” Clark is a Certified Financial Planner and the managing partner of the Financial Enhancement Group, LLC. Big Joe can be reached at bigjoe@yourlifeafterwork.com, or 640-1524.
