Why Diversification's Important To Your Portfolio
The Dynamic Wealth Report
January 2, 2009
What You Need To Learn From The Madoff Fraud
These last few weeks, it’s been all over the news. Bernie Madoff
… “made-off” with billions of dollars of his investors’ money. His giant Ponzi scheme ran for more than 30 years. It finally crumbled at the end
of last year. I can’t believe the number of people caught in his web of
deception. The part I find most shocking is not the amount of money he
stole, but the types of people he was able to con.
He managed to scam some of the smartest people on Wall Street.
His list of victims reads like a who’s who of financial investing. CEOs,
CFOs, portfolio managers, institutional investors, business people, even
charitable foundations. Investors with decades of experience on Wall
Street are caught up in the fraud.
His victim list wasn’t limited to the rich in America. Madoff stole from
some of the richest people in the world. Europe, Asia, South America. Madoff had a reach around the globe. He took billions from people who
should have known better.
The saddest part… investors who lost everything.
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The story of Thierry Magon de La Villehuchet is the most
heartbreaking. Mr. Villehuchet ran a money management fund and was
investing billions with Madoff. His own personal fortune, some $50
million was heavily invested as well. Villehuchet was personally
vouching for Madoff. He convinced his friends and family to invest. He
convinced clients and business associates.
Sadly, after the fraud was discovered Villehuchet took his own life.
Now, I’m not here to regurgitate the same news stories you’ve seen in
the paper.
What I want to do is highlight a huge lesson everyone should learn from
this mess. Unfortunately it’s a lesson that’s been taught before and no
doubt, will be taught again. The lesson is simple.
It’s the importance of diversification.
We learned this lesson from Enron a few years back… don’t put all your
money into one stock. Now we’re seeing it again with Bernie Madoff. The
key here, don’t put all your money in one investment strategy.
The victims of the Madoff scam are feeling the sting of his fraud. Some
of them however will continue onward. What was their secret?
They only invested a small percentage of their portfolio with the crook, maybe
2% to 5%. These investors knew the importance of diversification.
More importantly, they practiced it.
The smart investors periodically rebalanced portfolios. Cutting back on
one position, adding to others. Most importantly they spread their
investments between strategies. And inside those strategies they were
diversified as well.
Other investors weren’t so smart.
They were being lured into the trap by easy money and big returns. They
went “all in” on the strategy. Those are the investors who are
absolutely crushed by this fraud.
Diversification’s important. Not only across stocks, but across
strategies as well.
What do I mean by that?
Simply this: spread your portfolio between a number of different
investments. A big loss in one investment won’t wipe you out completely. You’ll be able to weather a big loss… and live to fight another day.
Many investors focus on diversifying in stocks. Erroneously they think
holding a large number of securities is the key. It’s a start, but not
the perfect answer. Diversification doesn’t help if you own all of the
automotive stocks, and their suppliers. An industry downturn is usually
devastating for all stocks in the industry – even the strong companies.
I like to diversify across asset classes. Start with stocks. Have a
portion invested in small, midsize, and large cap companies. Invest in
U.S. stocks as well as high quality foreign stocks. Then look to add
other asset classes. Tack on a bond fund or two, look at corporate,
municipal, and government bonds. Finally, add commodities, real estate,
and even options to the mix.
Investors fortunate enough to hold big portfolios might even look to
invest in hedge funds and private equity funds.
Every investor is different. The percentage of your portfolio you should
put into each asset class will depend on your specific risk tolerance,
time horizon, and investment objectives. Be sure to keep these in mind
when reallocating your portfolio.
Right now is the perfect time to review your holdings and rebalance your
portfolio. It is the New Year after all. Look at your portfolio and make
the necessary adjustments now. Start by evaluating your allocations
between stocks, bonds, and cash. Cut back on your largest holdings and
start researching new asset classes.
Take the time to do this now. It’s not hard to do, and it may save you
from another Bernie Madoff (or Enron) down the road.
•
Yum! Brands (YUM) was upgraded to a “Buy” at
Argus. The company received a $37 price target. The analyst highlighted
the growth potential in China as a key driver of the stock.
• California Water (CWT) was downgraded by Brean Murray
to “Hold”. The stock’s one of the few reaching new 52-week highs. They
think the valuation has gotten ahead of itself.
• Wedbush Morgan started research coverage on Family Dollar
(FDO) with a “Hold” rating. In this kind of economy, I’d expect the
company to perform well and warrant a better rating.
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