A random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing

EXERCISE 10: AVOID SINKHOLES
AND STUMBLING BLOCKS:
DIVERSIFY YOUR INVESTMENT

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STEPS
In these warm-up exercises, we have discussed a number of
investment instruments. The most important part of our walk
down Wall Street will take us to the corner of Broad Street—
to a consideration of sensible investment strategies with
respect to common stocks. A guide to this part of our walk is
contained in the final three chapters, because I believe
common stocks should form the cornerstone of most
portfolios. Nevertheless, in our final warm-up exercise, we
recall the important lesson of modern portfolio theory—the
advantages of diversification.
A biblical proverb states that “in the multitude of
counselors there is safety.” The same can be said of
investments. Diversification reduces risk and makes it far
more likely that you will achieve the kind of good average
long-run return that meets your investment objective.
Therefore, within each investment category you should hold a
variety of individual issues, and although common stocks
should be a major part of your portfolio, they should not be
the sole investment instrument. Just remember the teary-eyed
ex-Enron employees who held nothing but Enron stock in
their retirement plans. When Enron went under, they lost not

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only their jobs but all their retirement savings as well.
Whatever the investment objectives, the investor who’s wise
diversifies.
Recall also the sinkholes and stumbling blocks covered in
the section of chapter 10 entitled “What Are the Lessons for
Investors from Behavioral Finance?” We are all too often our
own worst enemy when it comes to investing. An
understanding of how vulnerable we are to our own
psychology can help us avoid the common pitfalls that can
make us stumble on our walk down Wall Street.
A FINAL CHECKUP
Now that you have completed your warm-up exercises, let’s
take a moment for a final checkup. The theories of valuation
worked out by economists and the performance recorded by
the professionals lead to a single conclusion: There is no sure
and easy road to riches. High returns can be achieved only
through higher risk-taking (and perhaps through acceptance of
lesser degrees of liquidity).
The amount of risk you can tolerate is partly determined
by your sleeping point. The next chapter discusses the risks

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and rewards of stock and bond investing and will help you
determine the kinds of returns you should expect from
different financial instruments. But the risk you can assume is
also significantly influenced by your age and by the sources
and dependability of your noninvestment income. Chapter 14
—“A Life-Cycle Guide to Investing”—will give you a clearer
notion of how to decide what portion of your capital should
be placed in common stocks, bonds, real estate, and short-
term investments. The final chapter presents specific stock-
market strategies that will enable amateur investors to achieve
results as good as or better than those of the most
sophisticated professionals.

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