October 15, 2008
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?