When I was picking stocks, I saw my portfolio lose 15% of its value in one day. Simply put, I had too many of my eggs in one basket or too many of my investment dollars in one stock. I wasn’t diversified. Sure, I could hit it big with a stock, but I could also lose. I saw the amount of time I was spending on picking stocks and knew it could be put to better use if I let the professionals handle my money.
My portfolio was under diversified, but many people also suffer from too much diversification of their portfolio or diworsification. Diworsification occurs when you continually invest in the same asset class and keep your risk low but hurt your overall return potential. It would be the equivalent of investing in many different mutual funds that only contained U.S. stocks. If you want exposure to the U.S. domestic stock market that is great, I highly recommend it, but pick a fund that gives you just that and move on.
My investment strategy has come a long way from my earlier days when I was picking and choosing stocks. I thought just like many that I could pick homerun stocks that nobody else could. I did well on some and poorly on others. I would come home every day from work and watch Jim Cramer’s show Mad Money. I soon realized that the effort I was putting in wasn’t yielding the rewards I desired. I quickly shifted all my investments to a mutual fund. Being young, I knew I wanted a large exposure to stocks. What better stocks to invest in than the U.S. Stock Market? Warren Buffett has been noted to say that when he passes he wants the remainder of his fortune put into a low-cost index fund that mirrors the S&P 500. That’s right, just one fund. If he wanted his fortune to be spread across many funds that mirrored the S&P 500 he would be subject to diworsification. I decided to follow Warren’s advice.
While my investment dollars are placed into a single low-cost Index fund that mirrors the U.S. Stock Market, not everyone will agree with this position, and that is fine. Investment advice can be given to you from a hired professional or you can decide on your own. My knowledge came about through the reading of numerous books. If you want to invest in South America, there are funds for that. If you want exposure to corporate bonds, there are funds for that. If you think that the pharmaceutical sector is the next big thing, then by all means find a fund that suits you for that investment. There are many ways you can invest your hard-earned money, but try and keep to the One and Done Philosophy when investing in mutual funds to prevent diworsification: Pick one mutual fund that covers the class or sector you are wanting exposure to and leave it at that. Not only does it simplify your portfolio, but it keeps you diversified and away from diworsification.
James Hendrickson is an internet entrepreneur, blogging junky, hunter and personal finance geek. When he’s not lurking in coffee shops in Portland, Oregon, you’ll find him in the Pacific Northwest’s great outdoors. James has a masters degree in Sociology from the University of Maryland at College Park and a Bachelors degree on Sociology from Earlham College. He loves individual stocks, bonds and precious metals.