"Risk" is really a term we hear so frequently, and yet not many of us really know what it means. Usually, we all think of "risk" as losing money because of a bad financial commitment or the economy tanking, like most people have seen happen to our houses.
Financial Planning
And sure, this kind of risk is real, yet it is not the only type of "risk" that's available, potentially waiting to hurt your security. Also, most of us have an understanding that usually, (but not always) the more "risk" you take, the higher the potential reward. You realize, like investing in your brother-in-law's "can't miss" pay phone business, or going short on gold futures on margin. You might get killed, but if the deal works, you can find rich.
This rule is fairly solid, but is not always the case. For instance, let's discuss the only risk you might be taking, that violates the guidelines of risk/reward. A risk, which is the most common risk we see people taking, which offers a much greater chance of loss, without the equally greater possibility of making money! What risk is this? The risk of NOT BEING DIVERSIFIED! Let's explain the easy concept of diversification. It is simply the idea of not putting all your eggs in a single basket!
We know this seems like a kindergarten lesson, but please bear with us.Even though being diversified seems like a basic foundation of your investments, Let me tell you that over 90% of the clients we have seen are so poorly diversified that they're at great risk!See, for those who have most or all your money tied up in the company you work for, for example, you are at great risk! We have seen people all the time who work for a company, have all of their insurance benefits with the company, have their profit sharing plan in the company, and own a bunch of the company's stock both personally as well as in their 401(k) plan or whatever! Or, putting all your money in the market as a whole. We still consider this as one investment, if that is all you have, even If you have many stocks inside your portfolio. If your company or the market as a whole sucks wind, you are at great risk!
Does some of this mean more to you in light of the 2008, and 2011 stock market roller coasters? There is little if any potential reward with this family to keep their whole financial security tangled up in this one company, or one type of investment.So many people are, taking all equally high potential of reward!
This insufficient diversification can be the most deadly risk you could ever take!You must be realistic inside your assessment of how you're diversified. You can't think you're safely diversified for those who have money in six different banks! While you've diversified amongst banks, you aren't DIVERSIFIED AMONGST TYPES OF ASSETS!
See, true diversification consists of being diversified by the different kinds and forms of investments! For instance, someone who has money split up between bank CD's, annuities, life insurance coverage cash values, stocks, bonds, real estate, foreign instruments, etc., etc... is true diversification!
Let's look at an example of how separating your money into different asset types could add incredible safety!Assume some investor has $100,000 to invest, and one option was to put it into a relatively low risk, low yielding account, as well as in the other case, splitting up into five $20,000 chunks.
And, if two of the five investments within the diversified option don't make any money, and the other three do as shown.Invest $100,000 @ 4% For 25 Years = $219,112 Compared To Diversifying Over 20 Years:
Invest # 1 - $20,000 @ Total Loss = 0
Invest 2 - $20,000 @ 0% = $20,000
Invest # 3 - $20,000 @ 5% = $53,065
Invest Four $20,000 @ 10% = $134,550
Invest # 5 - $20,000 @ 12% = $192,926
TOTAL $400,541
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Would you see how, even though one investment would be a total loss, and one made nothing, this investor still made more money by diversifying! (NOTE- THIS IS AN EXAMPLE ONLY FOR ILLUSTRATION PURPOSES, AND IS NOT INTENDED TO BE MAKING ANY PREDICTIONS OR PROJECTIONS. NO RETURNS ARE IMPLIED OR STATED.)