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The Dark Knight Falls: Why You Need to Diversify Your Wealth Beyond Asset Mix

By    |   Tuesday, 07 August 2012 07:44 AM

Conventional investment wisdom is to diversify your assets. That means you don’t put all your eggs in one basket. It’s good, common-sense advice.

But most investors don’t take it far enough.

Some investors just think in terms of one asset class. They think they’re diversified if they own a bank stock, an energy stock, a tech stock and a consumer goods stock.

But when the market crashes, all those assets are going to go down. That’s why it’s important to include real estate, commodities, bonds and other assets to diversify.

Yet, not even that is enough, as investors with Knight Capital Group (KCG) learned last week.

Due to a computerized trading program gone wrong, this firm managed to rack up over $440 million in losses. Shares fell 33 percent last Wednesday, followed by a 66 percent drop on Thursday before bouncing a bit on Friday. What a mess. Whether you were a shareholder or whether you let them manage your money, you lost big time.

Although the company has received a lifeline that puts new management in charge, but vastly dilutes existing shareholders, long-term concerns still remain.

That’s why part of your diversification plan should be among financial institutions. You shouldn’t have your regular stock account at the same place where you keep your 401(k).

Your savings and checking accounts should be with a traditional bank, perhaps even two different banks. If you invest in blue-chip companies and simply re-invest the dividends, you should look into a direct-stock-purchase program to buy shares directly from the company and not in your existing brokerage account.

Finally, diversification suggests that investors keep some physical precious metals close by as the ultimate insurance policy against the unforeseeable future.

And, if you’re going to have a third party investing your money for you, make sure that you’re only investing money that you won’t need in the event of a sudden market crash or cash crunch.

Yes, it’s not as convenient as having a one-stop place for all your money. But, you need to do it for the same reason you wouldn’t put all your wealth into one company’s stock.

When it comes to being a fiduciary, honesty is everything. When the hint of impropriety emerges, years and even decades of trust can vanish. A strong reputation can be a company’s most valuable asset. It can also be the easiest asset to lose.

If you do trust a third party with your money, at least know what they intend to do with it. If that strategy includes complicated computer models, extreme leverage and rapid-fire trades, it's probably just a matter of time before it doesn't end well for you.

What’s amazing about the collapse of Knight Capital, MF Global and Long-Term Capital Management isn’t that they did collapse. It’s the shocking speed at which they went from being perceived at the top of their game to nothing more than financial rubble.

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Tuesday, 07 August 2012 07:44 AM
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