Myth: Diversification will secure your 401k contributions

You know the saying, “Don’t put all your eggs in one basket”. The recommendation is to spread your money across mutual funds or various stocks. The reason, to mitigate risk that may occur to the company that ultimately affects your money. Unfortunately, you can’t control what occurs within (or outside) a company that may cause their stocks to crash.

For example, who knew a simple, displeasing tweet from someone named Kylie Jenner would cause Snapchat’s stock to tank. Snapchat went down 7%, losing 1.3 billion in market value! Another event, the 2015 BP oil spill. Before the oil spill, BP’s stock price was around $59. The company hasn’t fully recovered from the event, as of today their stock price is around $37.

The diversification strategy makes sense when it comes to non-systemic risk, that is, risk that occurs within a company. Another scenario: You just found out on the news, a CEO for one of your stocks committed fraud. Their stock price goes down, but your money is balanced because of this strategy called diversification. Right? But what happens when the market crashes? Is your money still safe?

This is called systemic risk, that is “undiversifiable risk” and it’s unpredictable, volatile. Growing up, there were specific life events that you were expected to experience. Graduate high school, then college, find a great job, get married, buy a house, start a family, and retire. Additionally, when we think of retirement, we imagine our home is paid for and our 401k will be able to fund our necessities.

Let’s go back in time to 2007. Bob is noticing the housing market slowing down but isn’t concerned since he has no plans of moving. Bob is planning to retire during the winter of 2009. Unfortunately, Bob doesn’t have a pension but rather a 401K and $75,000 in his savings. Little does Bob know, in 2009 the market will crash, becoming part of a domino effect into a financial crisis. Bob will notice during that time his 401k will decrease significantly, thus reevaluating his financial health to determine if he can afford to retire in 2009. This exact scenario happened to many Americans. Consequently, they ended up working more years to make up for the loss.

Time is of the essence for those near retirement. You see, working Americans in their 30s have time to make up and save money for retirement if the market crashes. The cycle of the stock market has its ups and downs, and eventually it will crash again. How great the losses? We don’t quite know. In 2001, investors lost around 80% of their savings, while in 2008, there was a loss of 56%. We are currently experiencing 10 years of uninterrupted gains, the longest period so far. The question is, are you prepared when the market crashes?

…Stay tuned for alternative solutions.

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