You’ve probably heard the old axiom: Don’t put all of your eggs in one basket. In the investment industry we have another like-minded saying: Diversification is the only free lunch.

Diversifying is old knowledge, as old as collecting eggs. It has the virtue of being true, and is simple enough to actually apply. We reduce the risk we take when we spread our money between different types of investments. That way, if one investment goes through a tough stretch, it doesn’t take our entire savings along for the ride. It just makes sense.

But this old knowledge is not always applied. For instance, many people own too much of their own company's stock. They receive some stock in their 401k as part of their compensation, and then leave it alone hoping for the best. Others only invest in one kind of investment, be it real estate or tech stocks.

So, why aren’t all investors diversified? Here are four common reasons, and lessons we can take from each.

Social and Peer Effects: People are still betting heavily on the latest trends or the next hot stock. The recent stock market gyrations are just the latest example of our uncanny ability to ignore the simple and wise (or boring) for the new and complex (which happens to be much more exciting). Do an internet search for “Dutch Tulip Mania” or “Tulip Bubble” sometime and you’ll see how far back this inclination goes. And there is no doubt taking a gamble is exciting….until you’ve lost your shirt. That is an expression for when you’ve lost big on a stock market bet. It turns out, being shirtless is not very exciting.

Why do we chase these trends? When we see other people making money, we easily think, “Well, if that yahoo over there can turn a profit, surely I can.” We don’t like to miss out. Some call this the ‘herd mentality’, and it’s a real source of fear for people. In her book Thinking in Bets, Annie Duke points out a key finding from research on happiness: most of the variation in happiness from person to person is accounted for by how we are doing compared to other people. Many people account for their happiness not in absolute terms but in relative terms, relative to those around them. Chasing what is working for other people comes naturally since much of our personal sense of happiness depends on it.

To stop this from affecting the way we invest, we must rely on the old wisdom which has stood the test of time. Every investment carries some amount of risk (at Core Planning, we use the term ‘variability’). However, if I make a series of sound investment decisions, what are the chances they all be wrong in the most extreme way, and at the same time? Not very high, thankfully. So keep your shirt, take your free lunch, and try as best you can to be grateful for what you have.

Confusing Control and Risk Management: In the field of behavioral economics, there is a well known concept called the Illusion of Control. It’s the idea that we believe we have a degree of control over outcomes which we simply don’t have. This is true for many areas of life, but it is especially true in investing. When others buy X stock it’s a mistake - when I do it it’s a master stroke because ‘I know what I’m doing’. This tendency makes it very easy for us to underestimate the kind of variability we are subjecting our money to when we make certain investments. Here is a fact about investing in the stock market every participant must come to terms with: the movement of stock prices is random. You do not have control of the outcome.

When you purchase a stock, you're buying a piece of that company’s sales, cash flow, debts, property, etc. Over time, good businesses will grow, poorly run or mistimed businesses will cease, and the stock market will move accordingly. In the short run, it’s anyone’s guess. Even in the long-run, how can you know what changes are coming - changes which might permanently alter the business environment? It’s simply not wise to invest your money in a single stock, or even a few stocks. If you’re going to invest in stocks, you need to build a portfolio. Or you can just buy a few index funds (funds which track the movements of hundreds, or even thousands, of stocks) and do something else with your life.

Confusing Familiarity with Low Risk: When we are presented with two choices and we are more familiar with one option than the other, we can easily think the thing we are more familiar with is less variable. This may not actually be the case, however. Your familiarity with an investment does not alter its risk profile. Diversification is still the best choice. And that option may be a solid, reliable company and make for a good investment. You still shouldn’t have what we call a ‘concentrated position’ in that company’s stock, say more than 10% or your portfolio. 5% or less is even better. Have I mentioned index funds yet? Our sense of which investments have more variability can have little to do with the actual investments themselves and more to do with our own psychology. Be honest with yourself.

Narrow Framing: Each investment you make does not live on an island. It’s part of a larger portfolio. And your portfolio is part of the larger picture of your life and goals. But when we focus too much on a specific investment we can frame our decision too narrowly. If you have a number of investments in that same area or sector or industry, does adding another one make sense for your overall portfolio? And does your portfolio make sense for where you are and where you’re going in life? Ultimately, your investments should serve you and not the other way around. There is no perfect investment, and if you miss one opportunity, there will be another. Be disciplined and patient, and remember your investments are a means to an end - the quality of life they help you live - and not ends unto themselves.