Marginal Revolution University
Published on 30 Aug 2016So far, we’ve been telling you what not to do when investing. Here’s what you should do: diversify.
Don’t put all your eggs in one basket. Definitely, don’t put your investment money solely in your employer’s stock. That’s very loyal, but it’s a terrible strategy. Just think of Enron’s employees. They had huge chunks of their retirement funds in company stock. Upon Enron’s collapse, many employees who were once multimillionaires ended up with almost nothing.
As you can see, diversification is much safer. Diversification reduces risk by spreading your investment across different assets, doing so without reducing potential returns. Plus, modern financial markets make diversification easy. For example, our favorite investment instrument is the low-fee index fund. These funds mimic a large market basket of stocks, like the S&P 500. The sheer variety in the fund is what mitigates the risk. It’s diversification for the win.
A quick reminder, though. Choose an index fund with low fees. Fees may seem trivial, until you watch them eat away at your investment. Imagine this: take a hypothetical $10,000. Invest that in a fund with a 1% fee, and you’ll have roughly $57.5K after 25 years, assuming an average 8% return. Now, invest the same $10K, in a fund with a 0.2% fee.You’ll get roughly $70K over the same quarter-century.
Our point is — when it comes to investing, simple is best. So for example, if your employer offers a 401K, take the offer!
That being said, you might believe that the market is irrational. Anomalous, even.
No worries.
Next time, we’ll tackle behavioral finance to see if you can profit from anomalies, and irrationality.
January 12, 2018
Investing: Why You Should Diversify
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