Another kind of investment diversification that individual investors should consider important relates to the failure or corruption of the financial industry intermediaries and fiduciaries that hold individual investors’ securities.
This meaning of diversification has nothing to do with scientific investment principles related to optimal portfolio diversification. However, it is still very important. Prudent investment practices would indicate that you should spread your investments across a variety of financial organizations, rather than concentrating them all in just one or two places.
With long-established financial institutions and with the various governmental regulatory oversight and protections that are in place, fiduciary risk tends to be relatively small, but it is still there. If an individual investor spreads investments across a variety of instruments with different firms to diversify away unsystematic risk, then that investor would also tend to be “diversified” with respect to the partial or complete failure of any particular fiduciary institution. Moreover, if a legitimate institution has some level of failure there may also be additional measures in place that protect some of the holdings of individual investors. These protections relate to fraud and the taking of assets and not to any protection for poor investment results.
Finally, many fiduciary failure problems that are reported in the media relate to individuals who naively entrust large portions of their financial assets to non-mainstream persons or financial entities that are subsequently found to be fraudulent. Simply having a personal rule that you will NEVER NEVER NEVER EVER put more than a limited percentage of your liquid investment assets, for example 5% to 10%, into any single investment will force you to diversify and reduce your exposure to investment crimes.
Stories about investment fraud often seem to include the phrase: “his or her life savings.”
There should never be a moment during your lifetime when your life savings are not heavily diversified across many investment vehicles and firms. There is no need to go to extremes about this. For example, holding your total investment portfolio in custody with a half dozen different investment firms – with multiple, investment funds – moves you toward both the scientific finance definition of diversification and the prudent fiduciary “diversification” definition.
If your life savings are invested in just one place, first don’t, but if you do, you had better do your utmost to conduct initial due diligence and ongoing monitoring. Even if you do, you should keep you [...]