Don’t Put All Your Eggs in One Basket

Kate and her husband Sam are discussing what they could do with some money they recently got from selling their car. Kate suggests that they could invest it in the stock market to get a higher return, compared to what they would get from just putting it in a bank account.

At first, Sam didn’t understand why just putting money somewhere safe isn’t good enough. But Kate reminded him that, when they invested for the long term, they needed to take some risk. Otherwise, there’s no way to make their money grow, because the average amount of money an investment earns over the long run is related to the riskiness of the investment. Riskier investments tend to earn higher returns, while less risky investments earn lower returns. But that doesn’t necessarily mean that riskier investments are better, since riskier investments also stand a chance of losing money. In other words, there’s a trade-off between risk and return.

Kate explained to Sam that every type of investment has some degree of risk. At the same time, he wants to avoid a total wipeout and losing everything he owns all at once. For example, if he owned stock in just one company, then he’s relying on the performance of just that one company. If it went bankrupt or even just lost money, his investment would be affected, too. As Kate explained, “that’s why it’s important to invest in a mix of assets and not put all your money in one place.”

“You shouldn’t have your investments and your job tied to the same company, and you shouldn’t have all your money invested in one company. Instead, spread it around.”

Next, Sam told Kate that he was thinking about investing in the company where he works, since the company’s growing and Sam is confident it’s doing well. Kate wonders if he’s been listening to her at all! She tells him that the whole point of putting his money in several different companies is that, if something unexpectedly bad happened to one of them, he’ll be cushioned to a certain degree. But if Sam invested only in the company where he worked and that company tanked, both his job and his investments would be in trouble. That’s where not putting all your eggs in one basket comes in: you shouldn’t have your investments and your job tied to the same company, and you shouldn’t have all of your money invested in one company. Instead, spread it around.

Price changes of a single stock and of a stock mutual fund

Kate asked Sam to think about the following scenario: What if he invested in several different companies that all manufactured umbrellas, and all of a sudden, the value of umbrellas crashed? That might sound unlikely, but think about when the tech bubble burst or when the real estate market collapsed. Therefore, it’s smart to invest in many different kinds of companies. Basically, you want the ups and downs of each investment to be as unrelated to other investments as possible, so that if some do badly, others will offset those losses.

Sam realized that he now understood the saying ‘don’t put all your eggs in one basket’ when it comes to investments. Learning this rule, he now sees, will be important for his financial future.