As we all well know, the surest way to derail a reasonable investment plan is to make a major mistake. Avoiding major mistakes begins with identifying multiple reasons to invest and is bookended with diversification. When wishful thinking overtakes a thoughtful approach to investment decision-making it is time to step back. I can’t imagine any investor – no, not even Warren Buffett – who hasn’t occasionally banged their head on the wall grumbling, ‘Why the #@&% did I do that?’ The last decision that I regret was getting over-concentrated in chemical companies not fully appreciating that they could get hit by declining petroleum prices. Fortunately, I caught myself early but the mistake set back my returns somewhat; arghhh. Buy for Multiple Reasons Five weeks ago in my first article on Seeking Alpha, I said, “[A] strategic approach to investing, combined with fundamental and technical analysis, has served me well; it holds the potential for alpha-level returns.” Well, the inverse of reward is risk and that is why this philosophy also points to the three levels of protection I seek in every stock I own. I buy for multiple reasons believing that I can be wrong on any one but that it is unlikely that I will be wrong on most or all: Invest into big, developing, scientific, socio-economic, and political patterns and trends that have not yet been reflected in the price of related equities. Trends like the 2014 Congressional shift and escalating global tensions that pointed the way to the end of sequestration and increased military spending with all the promise that holds for major defense contractors. Find companies with fortress fundamentals including rising revenue or the promise thereof, solid margins and earnings, strong cash flow from operations right on down to free cash flow, and a great balance sheet. Guard against overpaying technically. I am not a chartist and, frankly, I think a lot of it is voodoo. That said, there are a lot of institutional analysts and investors out there following this blip or that, interpreting tops and bottoms, fixated on second derivatives, you name it. Like it or not, good investors must be attentive to such things and so I always touch base with a technician before making any move. Think Broader about Diversification The other bookend of protection is diversification and this means more than simply owning a bunch of different investments. It means diversifying by industry sector, instrument type, and geo-politically. Industry sector diversification is fairly obvious. Anyone who was heavily into oil/gas and ores/metals over the last year got crushed. I myself have unrealized losses on two positions I hold in major integrated petroleum companies. However, those paper losses are relatively small because of the downstream/retail operations of these firms. In other words, the two oil firms I hold are diversified themselves. The setback is not enough to pull them under or to sink my alpha-level performance what for the decisions I have made in other sectors. The same cannot be said for investors over-exposed to shale production or deep sea drilling. As to instrument type, I am less disciplined. I sit on a 12-month supply of cash, own a house and a piece of a farm, and have directed that my charitable donor-advised fund be split 50:50 between equities and bonds. But that aside, today I am a stock guy; I do not hold bond or bond-proxy investments including preferreds or REIT’s. Occasionally, I will buy an option to gain leverage on a strong hunch, but not often. Competent financial advisors recommend a mix of products and it is well to follow their advice. For myself, if interest rates were nearing the end of a secular up-turn, I would plow money into bonds and bond-proxies, but not now. I have made a conscious decision not to diversify at this time into those types of investments. I am, however, a big believer in geo-political diversification. With some exception, most Seeking Alpha contributors and commentators are fixated on US investments. In general, they avoid discussing foreign bond or equities including in the form of ADR’s. Take five minutes to do a quick scan of the articles now trending on Seeking Alpha and you will see what I mean. This is unfortunate because just as individual investments, industry sectors, and instrument types go up and down, so do countries. Indeed, if the Fed finally raises interest rates it will have a deleterious effect on almost all US investments. However, the move could be very positive for some foreign investments including companies that heavily export to the US. I own such companies as a part of my diversification strategy; I am especially partial to transnational companies. Therefore, one way to avoid major mistakes is to diversify beyond just individual investments along vectors. Here are the number of stock positions I hold by sector x country. As you can see, my investments cover 9 industries with fully one third of my holdings in companies headquartered outside the United States (the number of positions I hold are proportional to the dollar amount of my holdings): Sector # Positions U.S. U.K. France Switzerland Japan Ag/Food 3 3 Autos 3 3 Defense 4 4 Energy 2 1 1 Financials 5 2 3 Pharma 6 5 1 Other Mfg. 2 2 Tech 2 2 Water 2 2 Total 29 19 1 3 3 3 In passing, I’d like to mention what I will call “crosstab risk management”. This topic interests me from my days doing business in the old Eastern Europe financing the likes of East Germany, the Deutsche Demokratische Republik. The DDR in the 1980’s was a financial disaster; I recall a business lunch at the Deutsche Aussenhandelsbank in which we were served toast, lard and charged water. Still, we did good safe business there because we confined our investing to short-term trade finance – bankers’ acceptances – as we did with other Comecon and Latin American “LDC” (lesser developed countries) at the time. In other words, we carefully selected a specific instrument type to apply to these very difficult geo-political circumstances. There are other special types of risks that also interest me. As but one example, dating back to my days financing commodity companies, I became very interested in counter-party risk which equates to default risk as defined by the inability of a party to live up to its contractual obligations. This type of risk can wreak havoc on highly-leveraged commodity production and trading companies because it can ricochet through the system with breathtaking speed. Its discussion is outside the scope of this article. However, given serious dislocations among shale frackers and smaller mining companies, investors in those sub-sectors would be well-advised to study-up on counter-party risk. Step Back When It’s Time Denial is the hope or dream that something is right when it is really wrong. One of the great setups for this is in the analyst or pundit who says, ‘It has already lost all the value it’s going to lose; it’s time to jump in!’ Newsflash: Just because a stock has lost 50% of its market cap doesn’t mean that it can’t lose another 50% of what’s left. Anyone who wants to see a perfect example of this need only review past articles and comments on SA about North Atlantic Drilling Company (NYSE: NADL ). Here is stock that in just over a year lost 90% of its value 50% at a time. National Bank of Greece (NYSE: NBG ) is another striking example. When wishful thinking begins to overtake a thoughtful approach to investment decision-making, it is time to step back. It’s time to take a zero-based approach to your holding(s) and diversification strategy. If nothing has really changed, stay the course. If things have changed materially, sell, take your lumps, move on, and don’t look back. This is the same philosophy that accomplished executives take with M&A’s gone bad. Which brings me to a final word on reward. People have a right to ask, ‘How can you possibly generate alpha-level returns from spreading yourself across 29 positions?’ It’s a good question and one I’ve asked of other contributors on SA who have offered no evidence that they generate even beta-level returns across their spectrum of ideas. I offer this answer: I’m not really spread all that thin. I focus first on potentially large developing patterns and trends and only then search out stocks to capitalize on them. So, I’m really investing in fewer big ideas. This is a lot different than a random walk or buying fund shares. On the other hand, if you don’t have the time, interest or expertise to take a more focused approach to portfolio management you’re better off finding someone who can including in the form of fund managers. Editor’s Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.