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Does Diversification Really Work?

An astonishing story about a marble miner reveals why diversification is essential.

You’ve probably never heard of ArtGo. The company mines marble for use in the construction of buildings.

For most of 2019, ArtGo was the best-performing stock in the world. It was trading for mere pennies per share in January, and by late November had reached $15 – an amazing gain of nearly 4,000 percent!

Even more astonishing was the fact that the company was losing money! So why did investors bid up the stock to such high levels?

There’s a simple reason: The stock was being added to MSCI indices. MSCI is the most prolific index provider on Wall Street. You’ve heard of the Dow Jones Industrial Average, created by Dow Jones & Co. to track the 30 largest companies in the U.S., and the S&P 500, created by Standard and Poor’s to track the nation’s 500 largest companies.

But you might be surprised to learn that MSCI has created more than 220,000 indices – tracking virtually every aspect of the global financial marketplace. Want to know how stocks are doing in Malta? MSCI has an index for that. Curious about how the U.S. dollar is faring against 49 other currencies? MSCI has an index for that, too.

Thousands of mutual funds and exchange-traded funds mirror MSCI indices. It’s a big deal when MSCI announces plans to add a stock to one of its indices because funds tracking the index have to buy shares of that stock. Likewise, if MSCI drops a stock from an index, those index funds have to sell that stock – so the fund can continue to reflect the index as accurately as possible.

So, when MSCI announced it was adding ArtGo to one of its indices, a bunch of funds quickly bought the stock. The sudden demand, coupled with a limited supply of shares, caused ArtGo’s share price to skyrocket.

But then, suddenly, MSCI analysts announced that they changed their minds: ArtGo would not be added to their indices after all. And just as suddenly, the funds sold their shares.

The result: ArtGo stock fell 98 percent overnight!

Indeed, in just a few hours, the stock went from being the best-performing stock of the year to the worst.

This is why we encourage you to diversify when investing. Anything can happen at any time, with little notice.

That has certainly been demonstrated by COVID-19. In just weeks, the stock of Norwegian Cruise Line declined 39 percent. American Airlines fell 34 percent. Noble Energy dropped 87 percent.

Not every stock suffered so badly. Walmart’s stock fell only 12 percent. And shares of Regeneron Pharmaceuticals actually gained in price during the crisis because the company is working on a treatment for COVID-19.

But these stocks, among a few others, were the exceptions. The majority of stocks fell dramatically a quick four weeks in February and March.

And that’s why diversification doesn’t just mean you should own lots of stocks. It also means you should own lots of asset classes – like bonds and government securities – in addition to stocks. Diversification can’t protect or insure you against losses, but it can help to protect you from getting wiped out if something terrible goes wrong with a single stock or a single asset class.

As investors in ArtGo learned. The stock is currently trading for 11 cents a share.

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