It’s the Principle of the Thing

May 15th 2018 | Posted in Behavioral Finance, Blog

Principles trump feelings, especially in the area of investment decisions.  When faced with an investment decision, we should always ask, “If I do this, will I be violating any proven principle?”

In his book Investing for the Future, Larry Burkett relates a story about a man who had been retired from Sears for ten years. Over the years he had accumulated a significant amount of Sears stock, and that holding represented a large portion of his portfolio. He and his wife were living comfortably in retirement on the income from that stock.

Larry, committed to the principle of diversification and looking at their situation objectively, suggested that the husband sell some of his Sears stock and diversify into other areas. The man had worked for Sears for 40 years, and since he and his wife had a strong loyalty to the company, they could not bring themselves to part with any of the stock that had been so good to them.

Shortly after Larry’s recommendation to diversify, other discount stores, most notably Walmart, entered the retailing business and substantially changed the way chain stores like Sears and J.C. Penney did business. The value of Sears stock plummeted, this couple’s assets declined by more than half, and they were forced to reenter the workforce.

Because Master’s believes in the principle of diversification, we strongly recommend that clients limit their holdings in any single security to 10% of their overall portfolio. We realize that diversification does not guarantee success but understand that it does reduce the long-term risks in an investor’s portfolio.

Unfortunately, we have witnessed other examples of what can happen if this principle is ignored. In Larry’s book, one chapter is titled “The Investment Hall of Horrors”. When we make investing decisions based on proven principles and not on how we feel, we are much less likely to find ourselves inducted into that hall.

Robert B. Miller | CRC® Advisor

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