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:

· Maintain a cash reserve. Right now, cash is king and frankly always has been. How much cash you should have depends on your individual situation. For instance, if you're a highly compensated individual and you think you might lose your job, you might err on the side of having six months or more of living expenses because it's probable that, in this job market, it will take some time to replace that high salary.

· Make sure you have enough insurance. Insurance hedges your bet against an expense you can't possibly save for in the short term, such as a disability. This is probably a good time to point out that it is Life Insurance Awareness Month. I would suggest you visit http://www.lifehappens.org to see whether you have the right insurance or enough insurance. For a good, independent source of information on life insurance, go to http://www.insureuonline.org, a Web site created by the National Association of Insurance Commissioners.

· Buy appreciating assets. You want assets such as property that have the potential to grow over time.

· Diversify your assets. What you don't want to do is put all your money in one particular investment. For example, investors are now going for gold, and buying high, I might add. Gold for December delivery jumped more than $100 over two days last week, to settle at $897 per ounce Thursday. Silver was up more than $2 over the same period, to settle at $12.70 Thursday. While gold can be a good addition to your portfolio, you shouldn't be overexposed in this asset class.

You can find some basic information about asset allocation at the Securities and Exchange Commission's Web site at http://www.sec.gov/investor/pubs/assetallocation.htm. I've also found a particularly helpful asset allocation tutorial at http://www.investopedia.com. Search for "A Guide To Portfolio Construction."

· Don't borrow to invest. But if you do, either have the cash to cover that bet if the investment tanks, or have enough money in reserve to make the loan payments until you can sell the asset or, in the case of a home, rent it.

· Borrow strategically. If you have to take on debt, keep it to a minimum. For example, if you're married, don't have two car loans at the same time. I've seen household budgets where the combined car loans were almost the equivalent of a mortgage or rent payment.

Think about how much of your net income is going toward debt payments. For so long, we've been told to use debt as a tool. Now we see that this tool can be a sledgehammer, crushing consumers and corporations.

"The people who will be best able to ride out the current economic downturn are those whose investments are diversified, have emergency savings, and little debt," Blandin said.

I'm a worrier, so I understand if you're in a panic from the domino fall of giant Wall Street firms. But as my husband tells me all the time, worrying over things you can't change is a waste of time.

The best you can do to get through this economic downturn is not to worry but to diversify.

· On the air: Michelle Singletary discusses personal finance Tuesdays on NPR's "Day to Day" program and athttp://www.npr.org.

· By mail: Readers can write to her at The Washington Post, 1150 15th St. NW, Washington, D.C. 20071.

· By e-mail:singletarym@washpost.com.

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