There's a common saying in the investment world, "Don't put your eggs in one basket." It means that you shouldn't concentrate all of your efforts and resources on one area, as you can lose everything. In other words, a wise investor keeps themselves covered for today and tomorrow by operating a diversified portfolio.
It's a misconception that picking one or a few hot stocks can lead to a comfortable life of sky-high returns. Just tell that to the many employees who suffered significant losses from being invested in companies such as Enron, once an industry titan that went bankrupt after a major accounting scandal.
Companies can rise and fall at any given moment, but it doesn't mean your portfolio has to follow the whims of luck or misfortune. There's too much at stake for the individual investor.
Instead, you can balance your risk by having a benchmark portfolio. This will be your standard portfolio that serves as the foundation for any other investments or trading you would like to do. Remember, 3 to 6 months of savings covered, plus a globally diversified portfolio. These are two requirements that should be met before you dabble in anything else.
You'd be surprised how many clients ask about stock tips and trading without having this covered. There's nothing wrong with trading or stock picking. After all, I am a trader. But, that should come after you have a solid financial foundation. These unprepared clients I mentioned oftentimes have little to no savings, unsure about retirement, and even if they have these covered, they're not diversified enough.
An uneducated investor who relies on a watchlist of stocks for long-term returns, or has a portfolio that's concentrated in one country or asset class is just a correction away from a life of ruin. This is why a balanced approach matters.
By diversifying your portfolio, you won't be exposed to specific stock risks or even country risks. In other words, your investments will align with your objectives rather than a particular theme or company story. Focus on what you can control: your portfolio mix, not the ups and downs of the market.
The conventional benchmark portfolio consists of 60% equities and 40% bonds. Depending on your objectives, you'd want to tilt this to more stocks if you're an aggressive (younger) investor, and hold more bonds if you're a conservative (older) investor.
The problem with the standard 60/40 portfolio is that it tends to skew heavily to your home country. For most of us, that's the US, where valuations are high relative to international markets. Let's break this down a bit in the next lesson.