Whenever I open my TikTok (which is rare, I have to say), I always see videos of tween finance bros saying things like “So-and-so stock is so hot right now!” and “This new crypto is about to take off!”
I want to debunk that kind of thinking right now. If you’re interested in long-term growth, you don’t want your investing strategy to rest entirely on one so-called “hot stock.” Again, the stock market relies on way too many constantly-changing factors for us to be able to predict with absolute confidence which stock will blow up—for better or for worse.
The best strategy is not to find the perfect, dreamy, big kahuna stock, but to build a portfolio around diversification. Nictionary note here: your portfolio is the finance-y nickname for the group of stocks you’re invested in.
Here’s another Nictionary definition for all of you who are thinking WTF is diversification? Diversification is basically the investing principle telling you not to put all your eggs all in one basket. The economist who applied this logic to finance won a Nobel Prize, which is absolutely bonkers to me because it’s a phrase we all grow up with. It’s like winning a Nobel Prize for the advice “If you lost something, check the last place you had it.” Just saying.
But even though diversification is an idea that is colloquial, it is a prize-worthy idea when applied to your finances, because it protects you from losing everything. It’s sort of like dollar cost averaging; but instead of spreading out the timing of your investments in order to increase the likelihood of buying at a good time, you’re spreading out what you’re investing in, to decrease the likelihood of a devastating loss.
Here’s how it works.
Say you have $100 to invest and you’re going back and forth between kicking it old school and investing in gold, or going super modern and investing in cryptocurrency. If you throw it all into crypto, in a perfect world, you’ll make a steady ROI. Let’s say your investment in crypto follows the stock market at large and you make 8%, or $8 after a year. But, what about a less-than-perfect world?
If you put $100 in crypto and the currency crumbles—poof! You now have a big ol’ zero in your brokerage account. You lost every penny of your $100 investment.
In a less dramatic scenario, if you don’t lose everything, but that cryptocurrency doesn’t “go to the moon” the way a finance bro on TikTok told you it would, you’ll have FOMO over not picking a stock that performed better.
Here’s how diversification would save you in those scenarios: if you put $50 in crypto and $50 in gold, then you increase the chances that you’ve picked a winner. If that perfect-world scenario comes to be and your crypto investment does earn 8%, you’ve still earned a solid ROI on your $50 investment, plus whatever return your investment in gold made. That’s great, we can be happy with that. But what we can be even happier about is that we’ve lessened our exposure to risk, because if the worst-case scenario comes true and that Dogecoin crypto investment turns out to be a catfish, you haven’t lost it all. You still have your $50 in gold to keep you afloat.
As this example shows, the payout can be better if you hitch your entire ride to a good investment, but oftentimes the risk is much higher than the reward. Remember— in the last example, you risked $100 to gain $8. See what I mean? High risk, low reward. In that scenario, I choose medium risk, medium reward, every time.
xo,
