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Rich Dad Scam #8: “Build a diversified investment portfolio for the long term”

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Why the rich focus instead of diversify

This is the final post I’m writing in a series on what I call Rich Dad Scams, scams designed by the rich to keep you in your place. They are the “rules” you’re supposed to follow that will keep you an employee and keep you from getting rich while the rich get richer.

The reason why so many people buy into these scams is because some of them, like working harder and saving money, used to actually work. If you followed them, there was a reward, but not anymore.

As we’ve seen in other scams like get out of debt, live below your means, and save money, the Rich Dad Scams I’ve identified keep you from truly putting your money to work. They keep you from turning your money into more money. In other words, they keep you poor.

Today, we’ll take a look at Rich Dad Scam #8, “Build a diversified investment portfolio for the long term.”

The portfolio diversification myth

The well-known British economist John Maynard Keynes once said, “In the long run we are all dead.” What he meant by this was that it was foolish to assume the economy would always balance out. This is why, for better or for worse, the Federal Reserve is always tinkering with financial policy. They believe you have to intervene to create growth in the economy.

Oddly, the financial industrial complex does not think this way when it comes to your finances. Instead they preach the mantra to “invest in a diversified portfolio of stocks, bonds, and mutual funds for the long term.” By this they mean let me manage your money by buying paper assets that you never sell in the hopes that the markets always go up…for a fee, of course.

This diversified investment portfolio myth goes something like this: if you spread your investments over stocks, bonds, and mutual funds and do not touch it but let it grow for years and years, you will have enough money to retire. This comes from the unshakeable belief that over time markets rise like magic.

If there is anything to be learned from the history of the financial markets, both long ago with the Great Depression and more recently with the Great Recession, it’s that nothing is guaranteed (except death and taxes). And that includes all the long-term investments that your financial planner will encourage you to buy, such as mutual funds, stocks, and bonds. Many people who were counting on the consistent, long-term growth of these markets had a horrible realization that short-term market effects can devastate you financially if you’re not prepared to act. Many people who were ready to retire during the Great Recession were instead financially ruined after years of buying into the advice to build a diversified investment portfolio for the long term.

It’s worth noting that financial planners didn’t exist until about forty years ago, when people were forced to take control of their own retirement funds through vehicles like the 401(k).

Financial planning is an industry created by the banks to make money off the financially illiterate. It takes only thirty days of training to become a financial planner. You have to go to school for more than a year just to become a massage therapist. The diversified investment portfolio myth is, at the end of the day, simply a very effective sales pitch that the financially illiterate have bought into hook, line, and sinker. In the process it has given birth to a $75 trillion industry.

What true portfolio diversification looks like

But, you say, my financial planner helped me plan wisely. We invested in lots of different things, so that if one company’s stock or one mutual fund takes a hit, there are others that will go up. This is one of those scams that make sense on paper. Of course, the more spread out you are, the more protected you are from losing money.

Nearly every financial planner will tell you that in order to be financially secure, you must diversify. By this they mean to invest in stocks, bonds, and mutual funds. Unfortunately, this is not true diversification. Rather it is diversification in only one asset class, paper assets—the class where banks make big money in the form of fees. Virtually ignored are the other asset classes, real estate, commodities, and business.

When everything you’re invested in is still on paper, it’s based on the same fragile economy and the same investment model. When the stock market goes down, it goes down everywhere, not just in certain places. Investing in Microsoft and McDonald’s won’t make any difference if the market tanks and everything goes down. Widely investing in different mutual funds spreads that risk around even more, but the risk is still the same and the hit will be the same when things go south.

True diversification is investing across different asset classes, not different stocks. This holds true with any of the asset classes. If I’m invested in condos, apartments, and houses, my portfolio looks diverse, but they’re all still real estate assets. So, I have real estate assets, commodities assets like gold and silver, business assets like my companies, and yes, I have some paper assets as well. But I know they’re not going to make me rich.

Financial education is the path to true portfolio diversification

The real issue here is that by buying paper assets at all, you’re putting control of your money in someone else’s hands. A CEO makes a bad decision, and you’re left holding the bag for his mistake when the stock drops. The only control you have over paper assets is to sell them. Holding on to them, you’re just playing a waiting game and crossing your fingers. And it’s even worse if you put those paper assets into a 401(k), you have even less control, they’re locked in, and you’re penalized for taking those funds out or borrowing against them.

True diversification requires financial intelligence, which comes from financial education. If you don’t have the desire to increase your financial intelligence, then by all means continue using your financial planner and investing in only paper assets, as those investments are set up so that even a monkey could do them.

If, on the other hand, you want to be rich, I encourage you to ignore Rich Dad Scam #8, “Build a diversified investment portfolio for the long term,” and instead increase your financial education and begin working towards true diversification.

Original publish date: May 03, 2013

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