GE and Why You Need to Diversify

General Electric made headlines yesterday, with an investigator alleging a massive accounting fraud at the company.  The result was GE shares falling 11% in a single day.  This news is the stuff of nightmares for investors.  And it’s a perfect example for why you need to diversify!

Often considered a safe “blue chip” stock, GE’s recent performance caused it to be knocked out of the Dow Jones Industrial Average in 2018.  As we saw during the Great Recession, huge global companies are not invincible.  And “too big to fail” does not always hold true.  By diversifying their investments among a broad basket of securities, investors can limit their exposure to unsystematic risk.

What is unsystematic risk?

Systematic risk and unsystematic risk boil down to whether or not a risk can be reduced through diversification.  For example, the risk of accounting fraud at a single company is unsystematic risk because it can be diversified away.  By spreading your investment amongst many companies, a problem at a single one reduces your overall loss.  Conversely, the risk of a global economic recession is systematic risk.  Economic downturns are felt by all investors, no matter how wide their investments are spread.  For this reason, picking and choosing individual stocks has greater downside than selecting a broad basket of investments.

A common approach for diversifying investments is through a mutual fund.  Mutual funds have grown in prevalence recently and have very low barriers to entry.  Vanguard for example allows investors to invest in certain funds with just $1,000.

But what if I want to invest in a particular industry?

Brokers commonly offer investments that focus on specific industries.  If your research tells you technology stocks will outperform the market, look for a technology sector mutual fund or exchange-traded fund.  This reduces the unsystematic risk meanwhile still exposing the investment to your industry of focus.  Or if you want to invest in the overall market, there are index funds that allow you to do just that.

What is your approach to investing?  Do you invest in mutual funds, pick and choose securities, or some combination of both?  Leave me a comment below!