Don’t Put All Your Eggs In One Basket
We have all heard the saying, “Don’t put all of your eggs in one basket.”
I heard it many times as a young child growing up in Lawrenceville, Georgia. One day that saying took on literal meaning. When age seven or eight, I walked down the dirt road to help our neighbor, Mrs. Still, a wonderful grandmotherly type, harvest the eggs from her chicken coop. The eggs were gathered in a few minutes. Soon, we were each carrying a full basket. As so often it happens with little boys, I got distracted and dropped my basket, breaking most of the eggs. I was very upset. Mrs. Still put her arms around me and said, “Don’t worry, Danny, that’s why I carry two baskets. See, all of the ones I’m carrying are still OK.”
It’s a good rule if you’re harvesting eggs and an even better rule if you’re trying to harvest investment profits.
This brings us to the question of the month:
“Dear Dan: I have a portfolio of mutual funds which has done very well over the years, but, in my annual review with my planner, I noticed that some areas, for example corporate bonds and small cap stock, have underperformed other areas, like the S&P 500 index fund and international growth funds. I want to consider dumping my underperformers and doubling up on my performance stocks. My financial planner says this may not be a good idea. What say you?”
It sounds like your planner knows this business. He is suggesting that you asset allocate across the financial spectrum. This is generally a good idea because picking a category winner is almost impossible. For instance, according to Zephyr charting services, provided by MFS Investment Management, in 1996, the best place to put your money was large cap value stocks (up 9.63%) and, in 1997 and 1998, large cap growth were the best (2.06% and 21.11% respectively). But, by 1999, emerging growth was the best (up an amazing 71.35%), while large cap value, our original winner, performed the worst of any category.
The point is to set up a diversification strategy. Let’s walk through those steps.
- Step One should be to determine the amount of risk you want to take and determine what asset-class allocation is consistent with your risk profile (for instance, 10% cash, 40% bonds, and 50% stock).
- Step two should be to diversify within those categories. In many instances, this may allow for a better rate of return. According to MFS, if between 1996 and 2003, you had invested in only large cap value stocks, you would have earned 4.68% a year. In comparison, large cap growth stocks earned just 3.64%. But, a diversified portfolio earned 4.81% with less investment volatility!
- Finally, you or your planner should then pick good solid investments in each category that are in line with your stated objectives. For example, in the international category, consider picking the best performers over several international funds. Even if the category performed badly, consider sticking with it. Next year, it may very well be the star of your portfolio.
Until next time, remember, your money matters.