DIVERSIFICATION: Don't put ALL your EGGS in one BASKET

For starters, allow me to provide a quick definition:

Diversification - (1) the process of making diverse; giving variety to (2): to divide funds with the expectation that the positive performance of some will offset negative performance of others (as in investing).

Diversification can be compared to a kitchen sink casserole; it takes time, requires a handful of ingredients and if not executed well, it can result in an experience that is hard to stomach.   Just as I believe in making use of food that may spoil, I also believe in diversification.  However, there are a few issues that investors should consider when developing a diversification strategy.

Most investors have been told to diversify their portfolio. They think if they buy companies that are in different industries that they will be covered if there is some adversity in the markets. The problem is that they do not fully understand the risks in the markets and how to offset those risks. To trade properly, you need to understand the degree of risk you are taking on by involving yourself in the markets.

There are several risks that any trader or investor will face.  Depending on the type of investment or trading vehicle you select, you will be exposed to one or many of these types of risk.  The levels of risk are listed in order along with the securities that are involved at those levels.

Systemic Risk – These are shocks to the entire financial system where there are few to no safe havens left. Everyone experienced this during the 2008 collapse in the global markets.

Asset Class Risk – Stocks, bonds, commodities, and currency markets all go through cycles where they are bullish or bearish.  You face the risk of entering at the wrong part of the cycle for any of these asset classes.

Country Specific Risk – Countries grow at different paces and can offer distinct opportunities and risks based on economic projections, political stability, and other factors.

Sector Risk – Companies fall into sectors: consumer discretionary, technology, basic materials, industrials, energy, consumer staples, services, utilities, and financials. The sectors also undergo bullish and bearish cycles, falling in and out of favor with investors.

Industry Risk – Within these sectors, there are many industry labels that inform investors about the nature of a company's products or services.  Companies also fall into cycles.  

Company Risk – Individual stocks have risks tied to the company's operations. Lackluster earnings, accounting irregularities, and corporate member changes are all issues you face.

If you trade or invest in individual stocks, you are exposed to the highest levels of risk.  Even if you try to reduce risk by buying many stocks in different industries or sectors, you still have the asset class and company risk. When it comes to minimising your risk, you want to balance risk and reward.  When you increase your risk, you also increase your potential for profit.  You will usually see larger price movements with stocks than you will see with exchange traded funds, or ETFs, but most ETFs hold up much better than individual stocks if a company encounters an issue. 

To really be diversified, you should invest or trade in multiple asset classes, such as futures or forex, to spread your exposure out over different asset classes.  Even if you own a tech stock and a financial company, you will lose when the stock market collapses.  Know your risks and manage them when trading. Success comes from protecting your capital as much as it comes from making winning trades.

Finance Myths

The most important factor that prevents to be financially secure is the trust in the age old beliefs and deceptive thoughts about money. The advice and guidance financial experts give may work well for many people, but at the same time may not fit in your personal situation. Tips about money sometimes can be life saving and sometimes life destroying. Before deciding on any plan about money spending or saving, you must keep in mind few very common myths about money.

1. You can save money by budgeting

A budget can no doubt help you save money, but it should be given a space as an item in your budget. It's important to set apart some money as savings.

While budgeting you are likely to set apart a fixed amount for an item. For eg., you might set apart 8000 for a refrigerator, chances are you're going to buy the product just by checking the money and not the item. You might get what you need at a much lesser price.

2. You are becoming wealthy as you are earning more

Generally, as you start earning more, you tend to shop a lot. You tend to buy things that you've always dreamt of. You actually ignore to think about savings imagining you've a lot of money. This is one of the reasons lottery winners declare bankruptcy soon. It's important to ensure that higher earnings equals to higher savings too.

3. Money can't buy happiness

The relationship between people, money and joy is not clearly captured in the phrase "Money doesn't buy happiness". The reality is money can buy happiness, specially for lower and middle class people. You can buy things that you actually need, this will of course give you contentment and happiness. If you want to spend quality time with your family, you need to go on vacation. A vacation is only possible if you have money to earn it. Quality time with family gives you happiness, which is the result of vacation that you buy from money.

4. The neediest is the first one to get the financial aid

There are many government aided programs that provide financial aid to people who are actually needy. However, most student based programs are merit based rather than need based. Even high income families can qualify for financial aid programs. This kind of programs makes rich people richer and needy people more needy.

5. Owning a home is better than renting

Keeping in mind today's financial scenario, it's better to keep your lifestyle flexible. Change in job or city isn't a rare thing. In a condition like this, buying a home can give extra mental pressure. You need to sell the house before flipping jobs or city. In a rented house, you have no hassle of managing anything. Also, you never know the estate prices might just go down when you need to sell the house. You might suffer loss also.

6. Red cars are expensive to insure

The truth is the insurance companies are color blind. It doesn't bother them if your car is blue, black, striped or red. The insurance rate for a particular model, make and age of the vehicle will be the same irrespective of the color.

7. Closing old unused credit cards is good for your credit

Your credit rating largely depends on your credit history wherein your borrowing history and balances on your credit card are shown. It's a good idea to keep unused credit cards also open. Credit card companies keep a track of old accounts, especially those with good credit history.

8. Saving for an emergency is more important than paying off your credit card bills

The ideal decision should be saving money while paying off your debts. Instead, when you keep saving money without paying debt, you are actually stocking up more debt. The high interest rates are racking up in your account. Your credit ratings are also getting affected.

9. Expenses will cut down after you retire

Nothing like this is actually going to happen. Retirement, generally, means old age and aging people cost more than babies. People theses days don't have their house completely paid off and prices of all products are getting higher not lower. Hence, retirement doesn't by any chance means lower spendings.

10. You don't have enough money to save

There is no guarantee that your income is going to increase or the time when it's going to happen. It's important to save some percentage of money with whatever you earn. You must start saving with small amounts.

A thought may be age old but it's not necessary that it'll work for you. So, whenever you hear something about finances, analyze your situation then take any action.

Rules Of Investing, Market Truisms and Axioms

If you are going to insist on investing your money into the financial markets then it is imperative that before you take on the additional risk you take some safety precautions. If you don't follow the basic rules – you will lose and lose big. 

P. Arthur Huprich published a terrific list of rules that you should consider as a starting guide.

Commandment #1: "Thou Shall Not Trade Against the Trend." If the market is going up then it is okay to have money exposed to the market – if it isn't, don't.

 

• Portfolios heavy with underperforming stocks rarely outperform the stock market!

 

• There is nothing new on Street. There can't be because speculation is as old as the hills. Whatever happens in the stock market today has happened before and will happen again, mostly due to human nature.

 

• Sell when you can, not when you have to.

 

• Bulls make money, bears make money, and "pigs" get slaughtered.

 

• We can't control the stock market. The very best we can do is to try to understand what the stock market is trying to tell us.

 

• Understanding mass psychology is just as important as understanding fundamentals and economics.

 

• Learn to take losses quickly, don't expect to be right all the time, and learn from your mistakes.

 

• Don't think you can consistently buy at the bottom or sell at the top. This can rarely be consistently done.

 

• When trading, remain objective. Don't have a preconceived idea or prejudice. Said another way, "the great names in Trading all have the same trait: An ability to shift on a dime when the shifting time comes."

 

• Any dead fish can go with the flow. Yet, it takes a strong fish to swim against the flow. In other words, what seems "hard" at the time is usually, over time, right.

 

• Even the best looking chart can fall apart for no apparent reason. Thus, never fall in love with a position but instead remain vigilant in managing risk and expectations. Use volume as a confirming guidepost.

 

• When trading, if a stock doesn't perform as expected within a short time period, either close it out or tighten your stop-loss point.

 

• As long as a stock is acting right and the market is "in-gear," don't be in a hurry to take a profit on the whole positions. Scale out instead.

 

• Never let a profitable trade turn into a loss, and never let an initial trading position turn into a long-term one because it is at a loss.

 

• Don't buy a stock simply because it has had a big decline from its high and is now a "better value;" wait for the market to recognize "value" first.

 

• Don't average trading losses, meaning don't put "good" money after "bad." Adding to a losing position will lead to ruin. Ask the Nobel Laureates of Long-Term Capital Management.

 

• Human emotion is a big enemy of the average investor and trader. Be patient and unemotional. There are periods where traders don't need to trade.

 

• Wishful thinking can be detrimental to your financial wealth.

 

• Don't make investment or trading decisions based on tips. Tips are something you leave for good service.

 

• Where there is smoke, there is fire, or there is never just one cockroach: In other words, bad news is usually not a one-time event, more usually follows.

 

• Realize that a loss in the stock market is part of the investment process. The key is not letting it turn into a big one as this could devastate a portfolio.

 

• Said another way, "It's not the ones that you sell that keep going up that matter. It's the one that you don't sell that keeps going down that does."

 

The table below depicts the percentage gain necessary to get back even, after a certain percentage loss.

• Your odds of success improve when you buy stocks when the technical pattern confirms the fundamental opinion.

 

• You can lose money even in the "best companies" if your timing is wrong. Yet, if the technical pattern dictates, you can make money on a short-term basis even in stocks that have a "mixed" fundamental opinion.

 

• To the best of your ability, try to keep your priorities in line. Don't let the "greed factor" that Street can generate outweigh other just as important areas of your life. Balance the physical, mental, spiritual, relational, and financial needs of life.

 

• Technical analysis is a windsock, not a crystal ball. It is a skill that improves with experience and study.

 

Always be a student, there is always someone smarter than you!

 

I hope this helps clarify the some of the issues that you wrestle with when it comes to managing your money.

Thinking about Saving - Think Again?

The things we need to consider, as investors, when thinking about saving for retirement and managing portfolio risks.  Here is a list of things to consider. 

• "Buy and Hold" investing will not work. Active management to participate in cyclical upswings, and avoid the majority of downswings, will be key.

• "Save More & Spend Less."  Savings will make a large chunk of your total retirement nest egg. This has always been the case.

• "Lump Sum Invest Vs. Rupee Cost Averaging."  Accumulate cash and invest in lump sums when things have become undervalued during the cyclical bear markets.  This will provide better returns over time especially when combined with an active management strategy.

• "Income Over Growth."  The income theme will continue to dominate investor psychology particularly in the baby boomer generation.

• "The Inflation Benchmark."  The real benchmark for investors to focus on is inflation - not an index.  Inflation, except in rare instances, actually compounds annually - stock markets don't.  Managing portfolios to limit losses and pace inflation will be key to ensure future purchasing power parity. 

• "Diversification."  Real diversification between non-corollary assets will be key in the future to hedge off market volatility and reduce emotional mistakes.

• "Real Assets."  Investing in physical real assets such as income producing properties, oil and gas wells, precious metals, private equity, etc. will perform better in a rising inflationary environment.  The key here is having a "real asset" behind the investment that will retain value even in deflating market environments.

• "Fixed Income"  Even in a rising interest rate environment actual fixed income, not bond funds, will provide income, low volatility and principal protection to portfolios.  Short duration ladders that can ratchet up as interest rates rise will provide portfolios with an edge over long only equity portfolios.

Of course, there are many other investments that will do well and these are just a few ideas to start the thinking process.  Furthermore, there will be fantastic and tradable bull market rallies like we have seen twice so far this century.  Being able to capitalize on those rallies will be critical in offsetting the rate of inflation and creating portfolio returns.  Unfortunately, the ensuing declines will also destroy all the gains and then some so being vigilant and disciplined in your risk management process will be critical.

However, the most important asset destroyed by reversion processes is "time".  It is the one commodity that you have a very limited supply of and no ability to replace.  Reversion doesn't mean that the markets "crash", although they certainly can, but the slow grind through the process will be like "Chinese water torture" for investors slowly destroying valuable assets over time.  Understanding the environment that we are in today, and will continue to face going forward, can help us make better decisions in both our planning and investment process.  Ignore the reversion process at your own risk.