Remember to diversify when investing
WASHINGTON - If your stock portfolio has been hit hard because you were 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 their 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, are failing because of too much debt and insufficient cash. "Many Americans are in similar positions," he added.
AIG, the big insurance giant, is in federal hands now because it couldn't sell off 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 if you break your leg and have to use crutches. 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 down.
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 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 likely 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 www.lifehappens.org to see if you have the right insurance or enough insurance. For a good, independent source of information on life insurance, go to 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 to more than $70 to close at $850.50 per ounce in trading on Sept. 17. The same day, silver was up $1.158 to $11.675. 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 www.sec.gov/investor/pubs/assetallocation.htm. I've also found a particularly helpful asset allocation tutorial at www.investopedia.com. Search for "A Guide To Portfolio Construction."
• Don't borrow to invest. But if you do, you better either have the cash to cover that bet if the investment tanks or have enough money in reserves 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 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 worry but diversify.