“If this investment went to zero, would you be okay?”

My father posed this question to me years ago, back when I’d just started my career. At the time, I was considering investing in a speculative idea that I thought would pay off down the line. The point my father wanted to drive home was simple. Could I afford to lose the money I was investing?

With the stock market reaching record highs seemingly every other day and investors pouring more and more money into cryptocurrencies like Bitcoin, I’ve been reflecting on this conversation with my father quite a bit over the last few weeks. The steady stream of positive financial news has served as a reminder that in times like these, when animal spirits are on the loose, people can sometimes become susceptible to ideas that might not be that smart.

For advisors – and especially those who work with younger investors who may not have much experience – it’s a good time to remind clients about the importance of maintaining a properly diversified investment portfolio.

Our research shows that wealthy Millennial investors in particular have a growing appetite for risk – and a strong attraction to illiquid investments. Many of these young adults have enjoyed a long stretch of beginner’s luck as investors as well – with the markets only moving in one direction as they’ve come of age over the last nine years: up.

With so many shiny, attractive investments out there all of a sudden (i.e., cryptocurrency), advisors have an opportunity to be the voice that my father was for me when I was a young investor. In times like these they need to hear an experienced person tell them, “Sure it’s okay to set aside some money to invest in that hot new idea. But your primary investment bucket needs to have that proper mix of stocks, bonds and alternatives – and frankly, be kind of boring.”

Investing 101: Diversify, Diversify, Diversify!

Our research shows that for wealthy Millennials, the typical investment portfolio today is a mix of U.S. stocks, real estate and cash – in that order. But many of these young adults are willing to sacrifice liquidity and take on greater risk in order to maximize their potential investment returns.

Millennials with money to invest are looking to pour more resources into private equity and hedge funds. I also noted in a previous blog post that they’re aggressively pursuing investment deals. Of course, it’s perfectly fine to take on these types of risk in an investment portfolio.

But when a younger investor brings risky investment ideas to the table, advisors should look to open their minds with the simple question my father once asked me. “Can you afford to lose your investment?”

The goal here isn’t to quash a young investor’s enthusiasm for a potentially lucrative investment. It’s to help them recognize the value of diversification as a fundamental investment tool. Help them to understand that as a risk management technique, diversification blends multiple investments to offset the risks of any single investment in the portfolio.

Want to invest in the hot new cryptocurrency, or finance a hot new film project? That’s fine. But then teach them how that type of investment fits within the broader context of their overall portfolio. Show them that they essentially have three buckets of investments.

The first bucket, which is arguably the most important, is the emergency fund. They need cash to support their spending and lifestyle. They also need this bucket to provide them some flexibility if there’s a market downturn or income loss.

The next bucket is the investment bucket – which is their major growth engine. As I said before, this one should provide the right mix of equities, fixed income and alternatives – and be boring. Retirement planning and college savings fall within this category.

And finally you have the aspirational bucket. Any funds that are left over can be allocated towards exciting investment ideas that get the adrenaline flowing. One of the biggest mistakes people sometimes make is they get too excited about this last bucket and invest more than they should. 

I should also add that in the end I wound up making the investment after speaking with my father. Ultimately, it worked out. But fortunately for me, I allocated from the third bucket, and didn’t bite off more than I could chew.

This is the latest installment in our series about issues facing high-net-worth families and their advisors. To learn more about what HNW Millennials want from their advisor, view our Coming of Age study.