{"id":2791,"date":"2012-06-27T08:33:08","date_gmt":"2012-06-27T12:33:08","guid":{"rendered":"http:\/\/canadianbudgetbinder.com\/?p=2791"},"modified":"2025-02-24T10:31:11","modified_gmt":"2025-02-24T10:31:11","slug":"understanding-investment-diversification","status":"publish","type":"post","link":"https:\/\/digitalskyweb.co\/canadianbudgetbinder.com\/2012\/06\/27\/understanding-investment-diversification\/","title":{"rendered":"Understanding Investment Diversification"},"content":{"rendered":"

Diversification…..
\nNo, I\u02bcm not talking about the time the TV show Friends added an African-American\u00a0woman to their cast… I\u02bcm talking about diversification in your investment portfolio.<\/p>\n

What is diversification?<\/p>\n

I feel there is a lot of misunderstanding about what investment diversification<\/em> is and how it can\u00a0protect your money when it comes to investing. The concept goes that if you have your\u00a0eggs in several different baskets, you aren\u02bct as exposed to losses that may occur in one\u00a0business, or one sector of the economy.<\/p>\n

Let\u02bcs look back at Nortel Networks as an example. This stock was all the rage back in\u00a0the 90\u02bcs (just like Ross and Rachel) and people couldn\u02bct buy enough of it. At one point\u00a0Nortel accounted for more than a third of the total valuation of all the companies listed\u00a0on the Toronto Stock Exchange.<\/p>\n

People started selling their other stocks and buying more Nortel shares. Even pension\u00a0funds (which shouldn\u02bct be risking anyone\u02bcs retirement money) were heavily invested. To\u00a0make matters worse, many people were buying the stock on margin, or using leverage\u00a0to buy shares with borrowed money.<\/p>\n

When the dot-com bubble burst, Nortel Networks stock fell from $124 a share in the\u00a0year 2000 to $0.47 a share by 2002. The company filed for bankruptcy shortly after that.<\/p>\n

So why did all these otherwise smart Canadians put all their eggs in one basket? Fear\u00a0and greed. Fear of missing out on a great investment and greed for not taking some of\u00a0their profits and diversifying into other types of investments when they had the chance.<\/p>\n

Would it surprise you to know that 70% of Canadians today are highly leveraged and\u00a0have hundreds of thousands of dollars invested in one single asset class.Many using\u00a095% borrowed money?<\/p>\n

That\u02bcs right, a record 70% of Canadians now own real estate. Even though home prices\u00a0have never been higher, people are lining up to invest in real estate the same way\u00a0people did for Nortel at it\u02bcs peak. By the way, American home ownership peaked at 69%\u00a0right before the bubble burst.
\nOur own government is so scared by this lack of diversification that they brought insweeping changes last week to try and cool down the real estate market.<\/a><\/p>\n

Don\u02bct get me wrong, I think investing in real estate is great. What I don\u02bct think is great is\u00a0ONLY investing in real estate. Or having the majority of your net worth in a single stock.<\/p>\n

Right now there are young people taking all the money out of their RRSP to put 5%\u00a0down on a $300k condo in Toronto\u02bcs over-built condo market. Most of them are trading\u00a0in mutual funds that hold a diverse basket of stocks and bonds to buy a condo that\u00a0won\u02bct be built for a year or two. They are trading in the safety of a diversified stock\u00a0portfolio that they own, to make a risky $300k leveraged bet on a single stock<\/a>.<\/p>\n

Think of all the people in the States who took out home equity loans when the value of\u00a0their houses went up. Many of them used that money to do home renovations and put in\u00a0a fancier kitchen or new bathroom. They took the profits from their real estate\u00a0investment and used it to invest in… more real estate! When home prices dropped by\u00a050%, no one cared that the house had a new kitchen, you couldn\u02bct sell it anyways.<\/p>\n

If you have the majority of your net worth in your home\u02bcs equity and are wondering\u00a0about the future of real estate in Canada, or how one would go about diversifying, I\u00a0highly recommend that you read Garth Turner\u02bcs blog.<\/a><\/p>\n

If you are just starting out as an investor and are wondering if there is a low cost, safe\u00a0way to build a diverse investment portfolio, I suggest you look into starting a couch\u00a0potato portfolio<\/a> as recommended by Money Sense magazine.<\/p>\n

Here you will learn how to build a diverse portfolio<\/em> that includes:<\/p>\n