Saturday, January 9, 2010

Diversified or Not Diversified????


Let me give you a quick review on Rule of Money #6; Learn the language of money. This is taken from Rich Dad's:Conspiracy of the Rich, the book that I'm reading right now.

"One reason so many people lose so much money in bad investments is because our schools fail to teach us even the basics of financial education. This lack of financial education leads to a misunderstanding of the language of money.For example, when a financial planner recommends you invest for the long term, a sophisticated investor would question the definition of long term. As Einstein discovered, everyhing is relative.

Another word often misunderstood is diversify. If you listen to most financial pundits, they will always say that smart investors diversify. Yet, to quote Warren Buffett in The Tao of Warren Buffett, "Diversification is a protection against ignorance. It makes very little sense for those who know what they are doing."

Another reason why so many people lose so much money is because they don't know what they are doing and they are not diversified, even though their financial planner tells them they are. Let me give you some examples.

  1. A financial planner will say you are diversified if you are invested in different sectors. For example, you may invest in a mutual fund of small cap stocks, large cap stocks, growth stocks, precious metal stocks, real estate investment trusts (REITs), exchange-traded funds (ETFs), bond funds, money market funds, and emerging market funds.While technically you are diversified into other sectors, the reality is you are not diversified because you are in only one asset class-paper assets. When the stock market tankedin 2007, all paper assets associated with the stock market tanked. Being "diversified" was of little use to those diversified in solely paper assets.
  2. A mutual fund by definition is already diversified-in paper assets. It is a fund made up of a diversified group of stocks. To make matters worse, there are more mutual funds than individual stocks. Therefore, many mutual funds contain the same stocks. A mutual fund is like a multiple vitamin. Buying three mutual funds is like taking three multiple vitamins. You may take three different pills, but in the end you are taking many of the same vitamins-and possibly even overdosing on those vitamins!
  3. Most financial planners can only sell paper assets such as mutual funds, annuities, bonds, and insurance. In fact, after 1974, when ERISA was passed, many insurance salespeople suddenly changed their professional title from "insurance salesman" to "financial planner". Since most financial planners are only licensed to sell paper assets, that is what they sell you. Most do not sell tangible assets such as real estate, businesses, oil, or GOLD and silver. So, naturally, they will sell you what they are allowed to sell, what necessarily what you need, and that is not diversification.
As the old saying goes, "Never ask an insurance saleman if you need insurance." You know what the answer will be. Two reasons why financial planners recommend diversification are because they can sell you more paper assets, and because it spreads their risk in case they are wrong. often, they don't have your best interests at heart.

There are 4 basic investment categories. They are:
  1. Businesses: The rich often own many businesses providing passive income, while an average person may have many jobs providing earned income.
  2. Income-producing investment real estate: These are properties that provide passive income every month in the form of rent. Your home or your vacation home doesn't count, even if your financial planner tells you they are assets.
  3. Paper assets-stocks, bonds, savings, annuities, insurance, and mutual funds: Most average investors have paper assets because they are easy to buy, require little management, and are liquid-meaning they are easy to get out of.
  4. Commodities-GOLD, silver, oil, platinum, etc: Most average investors do not know how or where to buy commodities. In many cases, they don't even know how or where to buy physical GOLD or silver. (now,you have you know where & how to buy gold right??)
A sophisticated investor invests in all four (4) categories. That is true diversification. The average investor believes they are diversified, but most are only in category 3, paper assets. That is NOT diversification."

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