If You Don’t Diversify, You Are Asking For Trouble

By Craig Erwin, Ph.D.

One thing financial advisors agree on is that diversification is the only free lunch. That means you get something of value without having to pay for it. Diversification means not putting all your eggs in one basket. You spread your money around to limit the risk of a disaster, such as losing all your money. You could spread your money around, say to indexes like the stocks in the Dow Jones Industrial Average (DJIA), which contains 30 stocks, or the Standard & Poors 500 (S&P500), which contains 500 stocks. Fifteen years ago Enron, an energy company, collapsed leaving many employees, who had failed to diversify, penniless. Had they diversified into 20 or 30 stocks, their risk of losing everything would have been much, much lower.Let’s say that you are trying to decide whether to buy just one of the stocks in the DJIA or all 30 DJIA stocks. If you decided to buy just one stock and you picked Intel Corp, your return would have been lousy because today’s Intel price is roughly the same as the price four years ago. You would have earned a much higher return if you had bought an index, such as the entire DJIA.

How about cryptocurrencies? Many experts like me consider buying cryptocurrencies gambling, not investing. A big problem with cryptocurrencies is that, unlike stocks, it is tough to diversify when you buy them and expensive if you do. There are over 8000 cryptocurrencies, so how do you figure out which to buy? There are no cryptocurrency index funds, like the S&P 500. And if you somehow get lucky and your cryptocurrency holdings rise sharply in price, you will get stuck with a very painful tax bill (on top of the high purchase fees). The taxes are so steep that some people have moved to another country to avoid paying the taxes.

Cryptocurrencies remind me of lottery tickets. It is more likely that you will be struck by lightning than that you will win the lottery. Better to stick with stocks, bonds, and real estate. When it comes to cryptocurrencies, just say no.

Do you own cryptocurrencies? If so, how did you figure out which ones to buy? When you invest, do you try to diversify? How?

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