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The Need for Diversification in the Stock Market

Why is it that some people only buy one no worse emotional low. The depression
or two stocks? Others may have 15 stocks can be almost unbelievable. There's also
but have 50 percent of their investment the issue of owning more than one type of
assets in just one of those 15 stocks. In investment. There are equity investments,
Wall Street we refer to this type of which are stocks. There are real estate
behavior as concentration. Some firms investments, and bond investments. There
call it over-concentration. When this are also venture capital investments,
happens in a brokerage firm it is always precious metals, and others such as oil
considered dangerous. It is so dangerous, and gas. To a large extent, you achieve
in fact, that if the brokerage firm is diversity in your investment strategies
using a concentrated stock position as by owning different types of investments,
capital, then the market value of the as well as investing in different
security in question is given a haircut. sectors. Let's go into a few real life
This means that the full market value of examples. We at believe we have already
the security is chopped by some fixed made the equivalent of a lifetime of
percentage in any capital computation. In investing mistakes, so learn from a few
other words, if you are of ours.Arrow Electronics It was
over-concentrated, you don't get full Christmas week in the early 1980's. One
value. Some of you may have margin of us was sitting at Bear Stearns as a
accounts. As you know, advocates cash limited partner at the time. We were
ownership of stocks. If you own stocks on doing very well as stockbrokers. It was
margin, it is our opinion that you will the period of full commissions (no
get sold out on margin. Normally in a discounting), and clients were doing
margin account you put up 50 percent of 10,000 share trades in $50 dollar stocks.
the value of the stock you acquire in Taking home an income of $500,000 to
cash. If equity falls below 35 percent, $1,000,000 in a year was no big deal at
you get a margin call. Now, brokerage the time. We were loaded up on Arrow
firms love it when clients have 15 or 20 Electronics, a NYSE company in the
different stocks in a margin account. If semi-conductor sector. Business was
there are some bonds in that account, fantastic, the future was bright, and
guess what, they love it even more. Why? things could not have been better. Since
Because brokerage firms know that stocks we were involved on the banking side as
represent risky investments. Something well, we had an open line of
can always go wrong in any one situation. communication to the company. We knew we
Maybe something can go wrong in any two had a good thing going. The telephone
situations. It's tough to see something rang on one of those beautiful days prior
go wrong in 15 situations. That is the to Christmas when New York City is the
essence of diversification. SPREAD THE place to be, Rockefeller Center all lit
RISK AROUND. It makes a lot of sense. up with a 50 foot Christmas tree and all.
Some investors own 50 to 100 stocks. This "Hello." A harried response, "There's
is because they think they need that many been a fire at the Tarrytown Hilton
to achieve the investment goals that they Executive Center, a lot of people are
set out for themselves. In business dead." "Okay, that's terrible, how does
school at a master's degree level they it affect me and by the way, what's for
teach you that to achieve true lunch today?" "Buddy, you don't
diversification you need to own something understand," the dead pan voice says.
approaching 14 equity positions. It has "What don't I understand?" "The entire
been the experience of that 6 to 10 executive leadership of Arrow Electronics
different equity positions is sufficient was in that fire." All of them, every one
to achieve diversification. The one thing of them had been killed by this monstrous
we know for sure is that it's not one tragedy. It was the worst Christmas
stock or two stocks. Own one or two and imaginable for the wonderful families of
you get killed.Putting all your eggs in this dedicated group of execs. The
one basket We advise all investors to own families never recovered, the company
several stocks and to own more than one never recovered in terms of the people
sector. Own more than one type of that were left, and the stock took years
investment (that means equities, bonds, to recover. It plummeted from $32 per
real estate, cash, you get the picture) share to $4 per share in a matter of
or you will have problems. Sectors refer days. The recovery was slow and hard, it
to stocks with broad themes. Examples was agony all the way back on this
are: * Energy * Semi-conductors * Housing particular stock. Arrow Electronics is an
* Auto * Consumer * Airlines * Personal example of putting all your eggs in one
Computers * Technology in general If you basket. It is an example of owning just
own 10 stocks, but they fall into only 2 one stock. SAB does not care how much you
sectors then you really have not achieved know about a company, things can go wrong
diversity in your portfolio. You see, and do go wrong. You simply cannot own
when they come to get Ford Motor, usually just one company because the risk on the
General Motors is not that far behind. By downside is too great. YOU MUST DIVERSIFY
the way, it's great on the upside to own IN ORDER TO SPREAD THE RISK.Copyright
everything in one sector when that sector 2006 Richard StoyeckRichard Stoyeck is
is going your way. There's probably not a the publisher of Subscribers get award
greater high in the world than when winning stock ideas from one of Americas
everything you own is going up. On the premiere money managers. Extraodinary
flip side, when you are overly track record has generated returns of
concentrated in a sector that's heading 36% per year for 6 years.
down, lower and lower every day, there is




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