Wednesday, February 08, 2006

Financial Fairy Tales -- #1

Fairy tales of the financial type tend to have unhappy endings.

There is a lot of financial advice that sounds wise - but is the equivalent of nibbling on the witches' gingerbread house.

Our first fairy tale: -- "Don't put all you eggs in Little Red Ridinghood's basket."

The advice, based on the old math based
Modern Portfolio Theory, is to diversify into ten or twelve unrelated investments depending on portfolio size.

If we were to pick ten investments - our first three choices will probably outperform the extra seven put together.

The realty is that wealth is usually made by concentration, and preserved by diversification.

Using that guidance it would seem appropriate to put all your eggs in one basket - and then watch that basket very carefully.

We can use Red's basket after all.

If your basket seems at risk - protect it. Cut your losses short by getting out of risky trades quickly.

Once you see a profit - let it grow. Don't be quick to exit with a small profit. As long as the reason you entered the trade is still valid - stay in the trade. Don't however let a profit become a loss - get out if you risk damaging your original clutch of eggs.

If you are already wealthy - you don't need me to tell you to diversify - just do it.

Diversify over time to maturity, over asset classes, in different countries; and any other way you can imagine.

Then send me a check for my good advice (and what big eyes I have).

We can then share that happy ending.




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