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Portfolio Diversification 101: Investing in a Unicorn vs a Herd of Cattle

Let’s face it. None of us can predict the future. We don’t know when the next stock market crash will happen, when the market will hit new highs, or which companies will be the next Unicorn. This is why individual stock picking is so hard. Yes, sometimes you get lucky and buy a stock like Apple when the company is in its infancy, and years later you become a rich bitch. But picking the unicorn of companies to invest in is like playing the lottery. Pure luck.

To increase your odds of winning the investing lottery, you can diversify your portfolio.

Portfolio Diversification Basics

Let’s start with some investing basics. Buying Apple’s stock is an investment. When that stock is grouped together with all of your other investments, this conglomerate of investments makes up your portfolio. Your investment portfolio includes all of your stocks, bonds, real estate, crypto currencies, etc. Your goal should be to receive the highest possible return on a portfolio with a level of risk that you are comfortable with. (To get a more comprehensive understanding of the risk/reward trade off, see this post.)

Stock picking, like playing the lottery, has a high level of risk because the odds of you winning are very low. If you manage to beat the odds and win, you will receive a high return, but most people lose money playing the lottery. The same concept can be applied to picking a unicorn company (this is a real term by the way). Venture capitalists use this strategy. They invest millions of dollars in lots of risky startups, and sometimes they get lucky and find a unicorn company and make shit loads of money. But most of the time, they’re losing money on their risky investment choices. This is like buying a bunch of horses with a disease that turns 1% of them into unicorns the other 99% die. The odds aren’t great and you’ll probably end up with a bunch of dead horses. So if you’re a venture capitalist, you can stop reading now. For the rest of you, let’s keep going.

Decreasing Your Risk with Portfolio Diversification

To decrease your level of risk you want your portfolio to be well diversified. This means that your portfolio contains various investment types, in several market sectors, and in diverse geographical regions. This type of investing is more like buying a herd of cattle than a unicorn. You have lots of cows (investments), and if one gets sick, you still have the rest of your healthy herd (portfolio) to keep making you money. It isn’t as shiny or fun as investing in a unicorn, but it is a much less risky investing strategy. So how do you choose well-diversified investments for your portfolio? You have several options.

Target-Date Funds

My favorite diversification option is to invest in a target-date fund. A target-date fund is a diversified fund that decreases your risk level as you get closer to your target date. This is popular with retirement accounts like 401Ks or IRAs where the target date is your retirement date. The premise behind this is that a higher percentage of your investments should be in riskier assets when you are younger because if you experiences losses, you have plenty of time to recover from those losses before retirement. The closer you get to retirement, the more impactful losses will be because you will have less time to recover from them. Therefore, you should reduce the risk level of your portfolio and lower the percentage of your investments in riskier assets as you age. Target-date funds do this for you. Each year they will reallocate your investments based on your target date and automatically reduce your risk over time. This saves a lot of time on your end, and an added bonus is that many of these funds have low or zero trading fees, and minimal maintenance fees.

Index Funds & ETFs

If you don’t want to use a target-date fund, you can research your own strategy for diversifying, and then pick investments that fit it. See the chart below for an example of different asset allocations in a portfolio.

Chart from an article by Fidelity Investments.

If you decide to build your own portfolio, two great options for diversifying are index funds and Exchange Traded Funds (ETFs). Indexes track a group of companies. You are probably familiar with these even though you may not know it. The S&P 500 index compiles 500 companies and tracks all of them together as 1 investment. The Nasdaq and Dow Jones do something similar. There are also lots of foreign indexes to choose from.

Index funds can be quite expensive, so ETFs allow you to buy a portion of 1 share of the index fund. This way, you can still reap the diversification benefits of the index, but at a fraction of the price. Both of these investments track the overall market in a region as opposed to a singular company. This can be beneficial when certain sectors of the market burst or perform poorly. A great example of this was when the dot-com bubble burst in the 1990s. If you were heavily invested in tech stocks and were therefore not well diversified, you would have lost a lot of money compared to someone who had investments in many market sectors. Again, when one cow is sick, you still have the rest of the herd.

The downside to structuring your own portfolio is that it is much more time consuming because you need to reallocate your investments at regular intervals (ie: annually) to compensate for any percentage changes that have occurred. For example, if you had a really great year and made a lot of money on your US stocks, you may now have too high of a percentage of your portfolio invested in US stocks and need to reallocate the extra funds to the rest of your portfolio. On top of that, you will also need to review your overall investment and diversification strategy as time goes on to make sure you are reducing your risk over time. Unless you are extremely interested in investing, I don’t suggest this approach.

Hire A Financial Advisor

The last option is to pay someone else to manage your portfolio for you. Unless you have hundreds of thousands of dollars or more to invest, I think this is a terrible option. Your portfolio manager will charge you tons on fees that will eat into any gains you make and lower your overall return. They also usually don’t perform better than the market, so why pay them to do what you can for free!

So there you have it! Don’t invest in the shiny unicorn. Invest in the herd of boring ass cattle! Slowly but surely and with minimal stress, they will make you a rich bitch!

12 thoughts on “Portfolio Diversification 101: Investing in a Unicorn vs a Herd of Cattle

  1. […] associated with different investment types, and how to structure your portfolio to reduce risk. (see that post here.) While investments vary in riskiness, they also vary in liquidity. Some investments such as […]

  2. […] More Investment Options – Unlike 401Ks, you will get to choose which financial services company you open your IRA with. Each company charges different fees and offers different services, so you are able to find the firm that fits your investment needs best. You will also have much broader investment options when compared to the options your company selects for your 401K. This allows you to further diversify from the 401K investment options selected by your employer. (See this post on the benefits of diversifying.) […]

  3. […] an earlier post (that can be found here), you learned why trying to pick a unicorn company to invest in doesn’t usually work out. […]

  4. […] open it with Vanguard.  (here are two great intro to investing posts on retirement accounts and building your portfolio.) The second largest investor in CoreCivic and Geo Group is BlackRock, so skip them […]

  5. […] Roth IRA, I have chosen to use a target date fund. (For more info on target date funds, see this post.) These funds are composed of a group of other funds, so first, you will need to determine what […]

  6. […] all about diversification, which means you’ll usually end up investing in a lot of boring things. Our post on how to build a diversified portfolio and manage risk will help you understand why this is […]

  7. […] as you age, you can transition to safer investments like dividend stocks. Just make sure to keep a well-diversified portfolio that also has other less risky investments in it, like bonds that provide many of the same benefits […]

  8. […] as you age, you can transition to safer investments like dividend stocks. Just make sure to keep a well-diversified portfolio that also has other less risky investments in it, like bonds that provide many of the same benefits […]

  9. […] Last year, I realized I could help other women by spreading my financial knowledge, so I decided to start a finance blog and some social media accounts to go along with it. My goal was, and still is, to provide women with the tools needed to make informed financial decisions, grow their wealth, and bridge the gender income gap. The first thing I did after setting up my blog and social accounts, was to try to find other likeminded women to follow. My financial education started with getting my BS in finance and an MBA and continued by listening to podcasts and reading books. I hadn’t used social media as a tool for financial teaching, so I wasn’t sure what to expect in my search for these likeminded women. I found no shortage of personal finance accounts, but most of them were hyper-focused on budgeting and becoming debt-free, which wasn’t what I planned to focus on. My focus was going to be on how to use debt properly, and how to grow your wealth through investing. […]

  10. […] holy grail of hassle-free investing is a target-date fund. These funds build you a diversified portfolio AND manage it for you over time. While index funds and ETFs are considered diversified stock […]

  11. […] become a passive investor, you need to open an account and build a well-diversified portfolio. There are several ways you can build your portfolio, and the way you choose will determine the […]

  12. […] the market cap of any funds or companies they invest in because a company’s size impacts how risky it is. In general, large-cap companies are the least risky because they are better established and […]

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