Diversify, diversify, diversify—it can’t be said enough. History has shown us, very recently in fact, how vital it is to diversify our investments. When a stock, mutual fund, or even a sector is hot, it can be tempting to think about investing a good portion, or all, of your money in it. However, this is the riskiest thing you can do. Smart investors know that in order to make consistent positive returns over the long run, your portfolio must reflect different types of investments and different sectors.

I have many clients who came to me with large holdings in their companys’ stocks. It’s very easy to accumulate a lot of stock in the company for which you work. Many companies only give their 401(k) match in company stock. It’s then up to the client to diversify that stock across different funds within his or her 401(k). I personally caution my clients about holding more than 5–10 percent in one stock or holding, although diversification alone is no guarantee that the overall return will be profitable.

One client of mine works at Johnson Controls. The company’s stock has done reasonably well over the past year or so, and my client had amassed a 401(k) worth more than $1,300,000. She watched the stock prices daily and was actively managing it herself. However, the entire amount was invested in Johnson Controls stock. This meant that whenever the stock price dropped even a little bit, her portfolio took a hit.

When we first met, she explained to me that she felt very comfortable leaving her money in Johnson Controls because she worked for the company, watched the stock price every day, and was confident that her 401(k) was stable. I discussed the importance of diversification with her. As is the case with every meeting, I left CNBC on so that I could stay constantly informed about what’s going on in the market. During our meeting, a trade for Johnson Controls came across the bottom of the screen; it showed the stock down by a few cents. Now, a few cents is not a big deal when the stock price is as high as Johnson Controls was at the time. However, my client’s entire 401(k) had just dropped noticeably during our meeting. I used this as reinforcement of my point about diversification.

At our next meeting, my client brought her husband in with her. She was still keeping her money in the Johnson Controls stock, which I again told her she should reconsider. I discovered that I had a very strong ally in this: her husband. He was very nervous about the fact that everything was in one stock. Though she wasn’t convinced to diversify totally, leaving only a small portion of money in Johnson Controls stock, she did move a portion of her 401(k) to different funds within her retirement plan. At our subsequent meeting, both she and her husband confided that they felt much more comfortable having money spread across different asset classes, rather than in just one stock.

Another client came to me recently because he was having problems with his 401(k). He had retired two years earlier and had rolled his 401(k) into an Individual Retirement Arrangement at an investment firm. He was now self-directing his retirement money. When he retired in 1998, his 401(k) totaled nearly $1 million. Following the advice of friends, as well as his own research, he spread the whole amount over five different individual stocks and one mutual fund. By the time he came to see me, his accounts were nearly $350,000. When we met, he was just sick with anguish. Not only had his accounts lost more than half their original value, but also he hadn’t told anyone about this. His entire family still thought there was close to $1 million. He also told me that a few of his friends (already clients of mine) had recommended coming to see me when he retired, but he thought that he would be able to manage his money better. He believed, as I’m sure many do, that since he cared more about his money, he would do a better job.

The mutual fund he had picked was a highly sectorized fund that had performed poorly. While other mutual funds were making money during 1998 and 1999, this fund had continued to lose value and underperform. The stocks he picked fared poorly as well. Two were health care stocks, two were Internet stocks, and the fifth was a small cap stock. All the stocks were valued at less than $3 when we met.

He knew that he needed to do something, but was so upset that he didn’t know what. Together we discussed diversifying his portfolio to help stabilize it. I put together a financial plan for him and showed him the different asset classes that were recommended. We were able to liquidate a couple of the stocks he held, as well as the mutual fund. We then invested the proceeds across different sectors, including international stock funds, high- and low-grade bond funds, and large company stock funds. Fortunately, we were able to preserve a lot of what remained. However, we had to keep some of the stocks he held because there wasn’t a big market for them. We are continuing to sell these off over time, as they continue to make the value of the portfolio jump around wildly.

Diversification into international funds may also be suitable for you. We have become a global-based economy, with countries becoming very connected. Staying invested in just one economy also remains risky. Each of the world’s largest markets has experienced a decline of 30 percent or more over the past two decades. Most notably has been the fall of the Japanese market. In just 10 years, the Nikkei dropped from 38,915 in December of 1989 to 13,406 in September of 1998. In July of 2001, it hit 11,609, its lowest point since January of 1985. Being invested in just the Japanese market would have spelled doom for that investor.

Likewise, I try to make sure that each of my clients has some sort of fixed investment that helps stabilize the portfolio when the overall market is down. While diversification won’t totally protect a client’s portfolio from losses when the market is down, it will help preserve most of the portfolio’s value. After analyzing a client’s current holdings, time frame, goals, and comfort level, I will recommend one or more investments that I believe will help them. In the past, I have recommended fixed annuities, which grow at a certain rate of interest and aren’t subject to market fluctuations; money market funds, which don’t vary with the market; or real estate investment trusts, which pay the client quarterly dividends.

One last point about diversification: beware of overlapping individual securities within different mutual funds. You may feel that you want to stay as light in the technology sector as possible, and think that you are invested in mutual funds accordingly. Ask your advisor to do some research to make sure that is the case. Many funds invest in the same, or similar, individual stocks, thus making your portfolio heavier in certain sectors than you may want it to be.