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Sleep Well with Diversified Investments

By John S Kiing

Divide Among Major Types of Investment.

A typical family needs several types of investment for the sake of risk minimization and stabilizing emotional involvement.

A family with young children and meager savings may justifiably feel that insurance on the life of the income-earner is more urgent than any form of investment. But from this possibly sensible beginning many savers jump to the absurd conclusion that life insurance takes care of everything, from cradle to grave.

When the only goal is to build up as much capital as possible, an investor had better put all of his savings into common stock or other forms of equity ownership. In the course of his lifetime, by owning only common stocks, well chosen, and reinvesting dividends, a saver can accumulate more capital than by having all or any part of his savings in fixed-dollar items. Well, then, why not concentrate on common stock? Why divide our capital?

A stockholder may get caught in a squeeze outside of his investing. If some emergency event requires him to raise extra cash, he may be forced to sell stock at a low price.

Uncontrolled emotions are another reason for not owning too much common stock. When stock prices drop, apparently a good many owners start worrying. If they don't act, their fears may not do any harm to their investments. But if they get so scared they sell out at low prices, then their long-range investment program has poor results. Presumably an emotional investor will not scare so easily if say, only 50% of his savings are in common stocks.

Retirement and Diversification Investment.

As an investor grows older, he has increasing need for care in balancing his investments. After retirement, in the absence of earned income he probably needs more income than he has, and this is an argument in favor of common stock. But if something causes him to sell stock at a low price, this cuts his future income worse than if he had sold some fixed-dollar item. And lacking an earned income, he has no way to recover his lost ground. So for diverse reasons, an investor owning nothing but common stock may some day wish he had put some of his savings into fixed-dollar investments.

Common-stock and fixed-dollar items can be bought in combination. Some investment companies have a balanced portfolio, containing both common stocks and bonds or preferred stocks. Thus one share in the fund combines some of the advantages of two or three quite different types of investment.

Here we mention just one aspect of a balanced fund. If an investor sells its shares when general-stock prices are low, he will probably not lose as much as in a common-stock fund, but at the same time, he will lose more than if he sold a separate fixed-dollar investment. So when an investor must sell something, shares in a balanced fund are not as good as owning two separate investments, one in common stock and one in fixed-dollar, and being able to choose between them as to which to sell.

Ratio For Diversification.

What ratio to maintain between the value of common-stock and fixed-dollar items owned depends partly upon the nature of an investor's other property, and his income. A man sure of holding his job and his pay, come fair weather or foul, has less need for fixed-dollar investment. And a salary that is slow to rise when the cost of living goes up is a reason for buying common stock as a protection against inflation.

Home-owning, being a form of equity ownership, some¬what reduces the need for common stock. Owing a big mortgage calls for more fixed-dollar investment, to make sure that mortgage-amortization payments can be met.

Assuming that the cost of living continues, as in the past, to show an average long-term tendency to rise, it is pretty hard for a man to maintain the buying power of the capital he has already saved, unless he puts more than half of that capital into common stock, real estate, or other equities.

When a man retires, his pension benefits are nearly always fixed-dollar. To offset this, a large share of his personal capital needs to be invested in stock.

John Kiing is a freelance writer and stock investor in U.S and Asian stock markets. He writes for 101StockInvestments.com - a FREE resource center for novice or seasoned market investors. This article could be distributed digitally as long as the website links remain intact.

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