Financial advisors have hammered into our brains that we must diversify our investments. “Diversify, diversify, diversify” has become a mantra for the financial services industry just like “location, location, location” is for the real estate industry. Diversifying is touted as a way of spreading your risk. However, some of the most successful investors do not follow this investment strategy. Here are some reasons why you might want to buck the convention wisdom of diversifying your assets.
Warren Buffett says diversification “makes very little sense, for those who know what they’re doing.” He holds concentrated positions in a few companies, rather than small pieces of dozens of companies. If you invest in many different companies, you will not have the time to keep track of all the information you need to know about them. Of course, he does not recommend that you invest in only one company. The Enron scandal demonstrated how easy it is to lose everything when you put all your eggs in one basket.
Even when the market is doing well, you are likely to get only average returns if your investments are spread among dozens of companies. Balancing stocks that are doing well with “safer” stocks that have more modest returns will result in a net return that can be mediocre, if not a complete wash. To keep up with the ever-rising costs of medical care and other expenses that matter when you are retired, getting a healthy return on your investments can make a difference on your cash flow.
Although diversification will keep you from getting wiped out, if you invest in only one stock and it fails, investing in 20 or 30 companies or more will not prevent your portfolio from losing value when the market takes a downturn. When the entire market tumbles, your diversified portfolio will lose value with the rest of the market.
How to Concentrate Positions and Spread Your Risk
Experts suggest that you can have the best of both worlds by choosing a few stocks in several uncorrelated sectors. Balancing investments in a higher risk industry with stock in a more stable sector can mitigate some risks while giving you the opportunity to possibly achieve a better than average return.
Concentrating positions in several stocks, rather than diversifying in dozens of companies, requires you to be knowledgeable and to stay informed about everything that could affect the value of those few companies. If you do not want to do the homework, it might be better for you to follow the conventional wisdom and settle for average returns.
This is not intended to serve as financial advice. Always do your own research, make your own financial decisions and hire the services of a professional to assist you. Investments always carry risk.
Forbes. “Here’s Why Warren Buffett and Other Great Investors Don’t Diversify.” (accessed July 25, 2018) https://www.forbes.com/sites/karlkaufman/2018/07/24/heres-why-warren-buffett-and-other-great-investors-dont-diversify/#7f0c0a334795