Every week on this show Cramer plays “Am I Diversified?” with loyal Home Gamers. Now, pretty much everybody agrees in principle that diversification is great. Everybody wants to be diversified in theory. But then when you go off and actually invest, you decide you don’t really want to be diversified in real life. Diversification is boring. It’s conservative. It limits your risk. It’s totally unsexy. Diversification is the biggest party-spoiler in the world of finance.
Cramer understands. When housing is rallying, of course you want to throw all of your money into that one really strong sector. But think about those people who were ruined because they owned too much tech when the bubble burst just a few years ago – or the Enron employees who lost everything because they only owned stock in their employer when that company collapsed.
Keeping a diversified portfolio – meaning you never have more than 20% of the money you’re investing in a single sector – is essential if you’re serious about investing. Over the long term, diversified portfolios perform better than undiversified ones, Cramer says.
The problem is that we’re just not good at processing downside risk – that’s just how people are programmed. We don’t intuitively understand that if we throw all our money in one sector, we could lose it all. It’s hard to feel that some of the stocks we own, especially those we like best, could be headed straight to zero.