When you pack for a vacation, you take into consideration the climate you will be visiting, the activities you will be enjoying, and any weather reports available. Given the predictable warmth of Florida, for example, would you pack just shorts and t-shirts? No. There might be rain. There might be a cold snap. You may decide to go to a fancy dinner. In other words, you want your suitcase to be diverse, so that you can adjust to most situations—especially unpredictable ones.
The stock market can be just as unpredictable as a journey out of town. Sure, you can have forecasts, projections, and expectations, but in the end, there is no way to know with 100% certainty where the market is heading. US News and World Report provided yet another insightful metaphor to help understand diversification: No one knows who will win the race, so bet on all the runners. As easy as this concept seems, there are still some pitfalls that physician investors can be tempted by when trying to diversify their investments.
The sure thing. Your friend Larry at the hospital has a son who is heavily involved in the tech world. He tells you that XYZ company has developed a new tool that is going to revolutionize our lives. Larry has been right about this sort of thing before, so you are very tempted to empty out your savings and throw it all behind this company. Whenever you are tempted to “all” anything, take a long pause to think it over. It is okay to allocate some of your investment funds into a potentially successful company, but never put in what you can’t lose.
Sticking with big blue. Okay, maybe Larry’s stock tip was a bit risky. What if you take all your money and invest only in proven, large cap, Dow Jones Industrial Average stocks? That’s not risky, is it? Large cap stocks, sometimes described as blue chips, are a great investment vehicle, but again the problem word is “all.” Although large cap stocks have less risk than unproven start-ups, they can still experience downturns. While they may bounce back, you need diversified holdings to balance your portfolio so that, when one sector flounders, another is holding steady.
Dividend hungry. Pay-outs are the loophole, right? Not necessarily. Some investors structure their investment portfolio to favor stocks that offer dividends (ie, profits shared with stockholders). Although dividends are great, the companies that pay them tend to have slow growth. It is important to balance dividend-paying workhorses with companies looking to reinvest profits into growth and innovation.
Playing it too safe. There are very safe, very low-risk investments that investors should consider adding to their portfolio—certificates of deposit, treasury bills, bonds, and money market accounts. These all have relatively low returns, but they offer safety and security. Unfortunately, sticking with only low-risk investments is a risk in and of itself. You may not be able to earn the returns you need to secure a comfortable retirement.
