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INVESTMENT TRAP #2:

Mistaking a lot of "stuff" for true diversification

Having stock in numerous companies can provide some protection. If one company fails, the remaining companies might support the portfolio. In a greater sense, though, this approach could hold more risk than the investor could imagine!

The point to consider is not the number of companies, but the number of asset categories that the portfolio spans. Let's say an investor buys stock in 100 companies, all in a single asset category - the S&P 500. His broker assures him that these are large and stable companies. What he is not told is that these companies typically move together in a step-rate fashion. When one company crashes, they all tend to crash together. When that market crashes, the investor is likely to lose massive amounts of money.

The largest, supposedly safest U.S. stocks that make up the S&P 500 lost over 43% for the three year period starting January 1, 2000. Why? Because the vast majority of the stocks move together. Even owning 500 stocks does not mean you are prudently diversified.

Here, the real crime was not the market drop. All markets rise and fall! The crisis came from investors feeling protected, with no sense for what could happen to their investments in poor markets. Sadly, many brokers and planners were equally ignorant of the real risk inherent in the portfolios they recommended.

Remove the mystery surrounding the investment process by understanding the myths about investing.

Investment Trap #3

Check out "Separating Myths from Truth."