This is important stuff.
Don’t put all your eggs in one basket. One goes up, the other goes down. Variety is the spice of life. These are all a way to think about diversification, that magic word that every investor should cement into their vernacular.
Diversification is the foundation behind every successful investment strategy and financial plan. By definition, diversification implies that you’re increasing the diversity of something. How does that apply to investing? It means you spread out the money you invest into different investments, you add variety to your portfolio, you seek a good mix. Why should investors like us focus on diversification? Here’s an example.
Say you have $20,000 saved up and can’t wait to invest it somewhere. You’ve heard all about the newest social media craze – a frozen banana delivery company called Gwen Inc (holla back). Gwen is crushing it in the frozen banana game and can’t keep up with overwhelming demand. They’re making money hand over fist and everyone is going… um, bananas. Investors in Gwen Inc are making crazy returns and you decide to do the same, because FOMO and this company is a sure thing, right? So you take your $20,000 and invest every penny into Gwen Inc.
A few weeks later, you see on the news that the farm where Gwen buys their bananas uses super high levels of pesticides on their fruit. There are a multitude of reports that Gwen’s bananas are making people sick. The public is disgusted, no one wants a Gwen’s banana ever again, and the company is facing a PR nightmare. Meanwhile, the stock price of Gwen Inc. is plummeting and your $20,000 investment is now worth $2,000 in a matter of days. The company announces they are filing for bankruptcy. Turns out there’s not always money in the banana stand.
If this story sounds familiar, it’s because it happens to investors all the time. Crypto might come to mind.
But think about this for a minute – instead of investing your entire $20,000 into Gwen Inc, you could have spread it out and invested in several companies instead of just one. Say you had diversified by investing only $5,000 into Gwen Inc and the remaining $15,000 into three other companies, let’s just say $5,000 each into Apple, Walmart, and Nike (to be clear, we are NOT recommending these stocks). You would have been much better protected from the Gwen Inc collapse. Sure, it totally tanked, but you’d have only lost $4,500 instead of $18,000 (the math = $18,000 loss on a $20,000 investment is 90%, so a 90% loss on $5,000 is only $4,500). Your chances would be very good that Apple, Walmart, and Nike would have kept clicking right along and totally unaffected by the Gwen Inc news.
Diversification applies to broader investing too. You can diversify and spread out your investments into different types of stocks, like technology or banking. You can, and should, diversify your investments across totally different classes, like investing into stocks and real estate and bonds and other stuff. That way, if the stock market is tanking, your real estate investments and bonds probably won’t follow suit. Pretty nifty!
The lesson here: You want to invest in a broad array of investments that don’t have the same characteristics as one another. By spreading out your investments, you lessen your overall risk by not having all your eggs in one basket. Some investments will do great, others maybe not so great, but you can weather the ups and downs with great diversification. And what’s even better, Firreo is here to help you with the most well-diversified investment recommendations you can find!
For lots more on how to crush the personal finance game and find early retirement, make Firreo your financial advisor. We’ll help you out of your job and on your way to financial freedom!