We all know that the financial markets cannot continue to climb indefinitely. Stocks have routinely collapsed throughout history, and bad things have been set in motion by a variety of factors, like speculation, inflation, asset bubbles, bank failures, mass unemployment, and geopolitics.
Market crashes wipe out what’s called “paper wealth,” leaving a wake of decimated “paper millionaires” who, according to Investopedia, are individuals with “a high net worth as a result of the large total market value of the assets he or she owns.”
Many of us with robust pensions or 401(k)s may well be considered “paper rich,” but the danger of this designation is that it’s based on future market potential and speculation.
“The paper millionaire’s riches,” Investopedia cautions, “usually aren’t safe until these holdings are liquidated and the gains are locked in. Otherwise, the gains can potentially be wiped out by a decrease in the market.”
Those of us who have watched our nest eggs recover and grow since the financial crisis must keep in mind that our retirement account is merely a reflection of its future potential because the dollar amounts emblazoned across our financial statements are yet unrealized. They are not economic reality, and our money could potentially go, as Icelandic billionaire Thor Bjorgolfsson famously quipped after the collapse of his savings giant, “to money heaven.”
This is why financial advisors continue to beat the drum of diversification. It’s an elaborate way of urging us to spread our money around and not go all–in on one thing.
When you consider that the chances of an eventual market crash or collapse, diversification is damage control, plain and simple.
But humans are a curious lot. We don’t like change. For some of us, it’s a loss of control; for others, it’s fear of the unknown. Our gravitation toward the status quo and tendency to “let it ride” are what keep Vegas in business and prompt opportunists like Warren Buffett to be “greedy” when “others are fearful.”
Keeping all of our money in one place or relying solely on an employer-sponsored retirement plan is just unwise. It’s an “all your eggs in one basket” approach that increases the likelihood that we could lose everything simply because we have only one strategy and one blueprint for our future.
“It is the part of a wise man to keep himself today for tomorrow, and not to venture all his eggs in one basket.” So said Miguel de Cervantes, the Spanish novelist, who coined the “eggs in one basket” idiom back in 1605 in part I of Don Quixote. Cervantes understood that humankind can be both idealistic and unrealistic—and therefore must always have a fallback or a plan B.
If a market event wipes out paper wealth around the globe, we’ll want to be holding something solid like a lance, or a sword, or gold.
Already in 2019, there have been several shots across the bow—but with the ongoing trade war, global slowdown, Brexit, Iranian tensions, IPO meltdown, and an impeachment inquiry into a U.S. President now underway, we’re reminded of Don Quixote’s curiously faithful squire who naively asks, “What can I see more than I have seen already?”—to which Don Quixote responds, “Thou hast seen nothing yet.”