Don't Put All of Your Eggs In One Basket
I hope you've all heard not to put all of your eggs in one basket before. If not, please read this article to see what I'm talking about.
If you have, maybe reading this article will be a good refresher as to why this saying is important when it comes to investing.
We all have our opinions on diversification, and how much diversification one should have in their portfolio's. Even with the wide range of opinions, one thing should be clear, never, never, never, put all of your money in one investment.
This morning I read an article on Marketwatch.com. It was titled: Putting Harvard on hold... and I could have sworn that I saw a headline also for the same article somewhere titled Advisor goes for broke... and loses..
I'm going to write about a few things from the article that I wanted to point out, but here's the link to the original full article if you'd like to read it as well: Putting Harvard on Hold - by Mark Hulbert
I'm not going to go into the details here, as you can read the full article there, but here's a couple of points of interest from the article:
The article is about an editor of an investment advisory service named Mr. Investment Advisor (no need for the real name here as this lesson is for everyone). It goes into explaining how Mr. Investment Advisor has a portfolio set up as a college fund for his 7 year old daughter.
He typically allocates 100% of the money in the fund on a single investment idea at any given time. (Did you hear that? If not, read that last sentence a few more times.)
Just recently, Mr. Investment Advisor put 100% of the College Fund into January $10.00 CALL Options for Arena Pharmaceuticals. That was last wednesday.
Without even knowing where ARNA is trading now compared to last week, investing 100% of the funds in an account with as single stock or etf is risky, but in a single CALL or PUT option is, well, let's just say it's something you probably shouldn't do if your in the right mental state of mind.
I'm no Options expert, but I would think that if I did put 100% of the funds from one of my accounts into a single CALL option that expired in 4 months, I would use some of those funds to buy some sort of protection using Options as well. Not Mr Investment Advisor though, or at least not from what was written in the original article.
The article goes on to point out that since opening this 100% position in ARNA, negative news was released regarding the company and the FDA. Not Good! The article points out that the CALL options purchased are now worth about 90% less than when Mr. Investment Advisor purchased them a few days ago.
Expanding on this current investment move, evidently the past track record of Mr. I.A. shows similar patterns. There are a couple of years that were fantastic, but over a longer term, average annual returns produced a loss, as compared to a small gain for the stock market as a whole.
This is a typical, and dangerous pattern that occurs with many traders and investors. They have a few good years of say 10-30% years, and then they have a few larger losing years and they never get ahead over the long run. The thrill and excitement of the opportunity keeps them going. (And by the way, it doesn't have to happen over a few years either. Short term traders can run into the same problem on a day to day basis.)
Don't put all of your eggs in one basket! Don't even think about doing it! This was too sad a story to read and I don't want to be reading about you one day also.
If you are going to trade stocks or options, and particulary options, don't do so without learning about money management and position sizing. If you want to learn more about options trading from a couple people I know that concentrate on building long term wealth, slowly and without using all of your funds in one basket so to speak, here are links to their sites: Great Option Trading Strategies and Learn Stock Options Trading.