Just joking, of course, but I didn't really get the reason for the necessity until the stock market woes of 2008. Diversification is MUCH more than simply five different companies from five different industries or sectors. In my case, I learned it by owning too many High Yielding REITS and Master Limited Partnerships. They generally move very slowly. Never as quickly as momentum plays. The high yields make it a particular favorite of retirees or retirement portfolios or, in my case, a novice trying to earn some money amidst her losses while figuring out what she is doing. I don't remember all of the particulars of why what happened happened. The stock market had too much margin action, I remember that.
When you buy something on margin that means you have borrowed money to make the purchase. Usually from your broker. (Never ever ever do that by the way. Never ever trade stocks using margin.) When the world goes crazy and bubbles are bursting, brokers can be known to do something known as a "margin call." Which is essentially an abruptly announced balloon payment. Unlike the local loan shark, your brokerage can't break your knee-caps, but if you don't pay up, they will sell off all of your positions. Now that's bad enough for you and I may feel sorry for you, but at the same time, all this margin calling 'en masse' gives all of us who paid for our trades fair and square a nose-bleeding roller coaster ride.
So one element of my lesson learned was caused by margin calls. Another had to do with the fact that those high yielding REITS and MLPs were owned largely by retirement funds. Something about the world dynamic and the margin calls caused the hedge funds and mutual funds to begin dumping their high yielding holdings. (Probably because anything that is "high yielding" also involves "higher risk" and individuals and institutions who are "higher risk" are more likely to cash out completely when the world is caught in crisis. Think of it this way. What is a recession or depression really like to anyone who has plenty of money? It's like a big close out sale.)
Hedge and mutual funds began to bail on those slow moving, high dividend names and watching them drop like a momentum player who had had a bad day was very startling. But it taught me a lesson. There is much more to diversification than simply five companies from five different industries. You are trying to protect yourself from getting slaughtered on the downside when a big market event happens. Sometimes that means a particular industry or sector, like during the infamous "Dot Com" bubble, but other times it could mean that Wall Street is getting gun-shy about momentum or growth names and they only want to own staples or companies who make things consumers "must" buy as opposed to luxury items. Changes in the market can happen like that without any noticeable world crisis too. A financial policy will change. Bond yields will change accordingly and a group of investors "in the know" to the larger implication of those bond yield changes will cause a hot sector to cool and a cold sector to catch fire. The way I look at it is this. Those "in the know" investors aren't doing anything else as a day job. A lot of them "live" stocks 24/7 too. Much more than a 40 hour work week. It is what they talk at work and what they talk at parties. I can't hope to ever have my finger on the pulse of the market anywhere near as completely. Diversification helps me limit my unavoidable losses due to what I could not know.
No comments:
Post a Comment