What Happens When We Forget To Diversify

By Michelle Singletary
Sunday, September 21, 2008

If your stock portfolio has been hit hard because you are too heavily invested in the financial sector, sob.

If you acquired more debt than you can handle, holler.

Go ahead and get it out of your system. Then learn from all this mess.

What we are seeing was badly needed and inevitable. And really, where did it all start?

It began when just about everybody and her mama -- banks, brokerages and individual borrowers -- forgot one basic principle of money management: diversify.

"Investing is often thought of separately from the other components of one's financial life, such as a mortgage, insurance, credit cards, but they all should be looked at as a whole," said Don Blandin, president and chief executive of the Investor Protection Trust, a nonprofit investor education organization. "If one part is not working, it can hurt your entire financial situation."

Blandin said financial companies, such as Lehman Brothers, were failing because of too much debt and insufficient cash. "Many Americans are in similar positions," he added.

AIG, the big insurer, is in federal hands now because it couldn't sell off its assets fast enough or borrow -- from private sources -- to raise cash to pay its debts.

When you diversify, all you're really doing is hedging against a future unknown. It's like using crutches after you break your leg. You have to distribute your weight just right to keep from falling or putting too much pressure on any one side of your body. The same is true with your money.

You have to be strategic about accumulating cash, debt and assets. If the distribution of any one of those areas is way off, you can fall.

If you stockpile too much cash because you are too scared to invest, you risk losing your purchasing power to inflation. If you overload on debt, you can fall. If you put all your money in one type of asset, you risk dropping because you can't sell the asset to raise needed cash.

Here's how you can hedge against financial risk in the future:

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