Never Forget These 2 Investment Rules

We’ve all heard plenty of rules of thumb when it comes to investing. Two rules in particular have been on my mind a lot lately, given events in the news.

Regardless of your individual investment profile, you should always heed these twin rules. They’ve survived the test of time.

Rule #1: Keep an Emergency Fund

Consider this a “pre-investing” rule. Before you start investing in assets that can decline or get tied up for a certain period, you should maintain an emergency reserve. Most financial experts recommend six months, but that depends on several factors.

If you are trained in a field that is always in high demand, six months might be excessive. But if you work for, say, the federal government and you have no idea when you might get paid again, six months might not be enough.

Consider the interminable government shutdown. I’m a little surprised at the number of people who find themselves in immediate financial difficulty because of a missed paycheck. If missing a paycheck will cause you to miss your mortgage payment, you need to make budgetary adjustments until you have a little money set aside.

Don’t think about investing until you have created a sufficient financial cushion. Consider this the most important condition to satisfy prior to putting money into the stock market.

Rule #2: Always Diversify

Assuming you do have extra money to invest, always seek diversification.  You’ve heard the expression: don’t put all of your eggs in one basket. It’s true, otherwise your nest egg could get busted.

Two corporate events underscore the importance of this fundamental rule. One is the announced bankruptcy of electric utility PG&E (NYSE: PCG).

The PG&E bankruptcy stems from the company’s liabilities as a result of the devastating “Camp Fire” in California in November.

If PG&E had been part of your diversified portfolio, the 85% drop in its stock since November would still hurt, but it wouldn’t ruin you. However, if you were overly concentrated in the company—or if, for example, you worked for the company and had your 401K primarily tied to PCG shares—your retirement savings could be wiped out.

Enron is a grim case story of this rule. Many employees who had concentrated their retirement portfolios in the stock of Enron lost their life savings when the scandal-plagued energy firm imploded in 2001. Employees who had watched their 401Ks swell up into the millions as Enron grew, ultimately saw them shrivel to nothing. Don’t let greed ruin your portfolio. Let fear keep you safe.

I typically won’t invest more than 2%-3% of my portfolio in a particular company. Presently, one of those companies in my portfolio happens to be retailing icon Macy’s (NYSE: M), which had performed well for most of 2018.

However, earlier this month, Macy’s announced disappointing sales. Shares quickly shed 20%, but because I’m highly diversified the drop didn’t exert an overly harsh effect on my overall portfolio. Sometimes investors hold companies that blow up in their portfolios. Never put yourself in the position that such a blow-up would wreck your portfolio.

 

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