benefits of basic diversification

One of my more interesting diversification stories happened in 1999, right before the dot-com crash. I was meeting with a prospective client but I think he was more interested in bragging about his portfolio’s results in 1999 than in hiring a financial advisor.

I asked him if his portfolio was diversified, and he responded with an emphatic “yes.” He went on to say that he held Microsoft, Intel, Dell, Cisco and Hewlett-Packard. Obviously this type of so-called “diversification” did little to help when the technology sector crashed the following year.

The goal of diversification is for the value of assets not to move in the same direction all the time.

Here is a more alarming true story of an attorney who called me to counsel her 82-year-old client. The widow had a $2.5 million estate.

I proceeded to explain my views on asset allocation, talking about stocks, bonds, commodities, and broad market funds with hundreds of different positions each, etc. She volleyed back, “I have no interest in your risky stock market investments. I’m a conservative investor!”

financial diversification

I then explained the concept of “all your eggs in one basket,” and she retorted that her investment was exempt from my concern. According to the client, her investment could never fluctuate and was as safe as a bank CD. The air was tense so we agreed to disagree and I left the meeting.

Our original meeting took place in June of 2008. Three months later, her $2.5 million of Washington Mutual stock was completely worthless, and she was bankrupt. I have to admit that I thought Washington Mutual was a buy when I chatted with her. I remember suggesting at least selling some of it. But no matter how much I may like a particular investment, I also know you need to have multiple baskets, since there are no sure things!