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A Shock with a Bigger Shock

Posted by Kelly Chung on January 7, 2009

Today’s crisis differs in complexity, speed and scale. We live in a complicated financial system. Almost every financial instruments connect to fixed income, especially, sub-prime loans. They are very complicated and not transparency. It is very hard to calculate the risks. The complexity of these financial instruments are not easy to comprehend.  I came from fixed income groups when I used to work for wall street firms.  The credit crisis and the downturn in world economies may offer a useful lesson: diversify your portfolios. You should have Treasury bonds, money market fund, corporate bonds, cash equivalents, currencies and gold in your portfolios. I got a call from my friend four months ago. He is an oncologist (cancer doctor). He wanted my opinion about his investments. His portfolio has some pharmaceutical stocks and REITS. Since he still receive income from his clinic, I suggested him to hold xyz (I can’t reveal it here!). Plus, he could sell his practice in one day. All his need is capital preservation. I suggested him that a good portion of his portfolio should be in stable, income-producing investments. Last year another friend of mine is an anesthesiologist. He told me he invested all his money in commodities. Looking back I thought it was a smart move. Now, I have a different opinion…As you know all commodities got crushed this summer due to slow growth in the global economy.

With a diversified stock portfolio, risk is reduced because different stocks rise and fall independently of each other. On a broader scale, combinations of different investment assets may well cancel out each other’s fluctuations in price, reducing the overall risk.

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