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Author Topic: D-D-Diversification Junior  (Read 758 times)

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D-D-Diversification Junior
« on: June 20, 2011, 06:42:29 PM »
   I had a little argument the other day with someone about diversification. Well not so much an argument but more of a debate. Now, I understand diversification and the reasons for why it is used, but I don’t think people realize that there are also some pitfalls that come with it. But let’s look at the positives first.

1.   Safety – diversification “should” provide safety in that by being diversified there is greater probability that one’s portfolio will fail. I completely agree with this, however it must be clear on what being diversified means. It does not mean owning a bunch of different stocks that are all in the same industry. It means you need to own a mining industry stock, a tech stock, a clothing store stock etc. That is true diversification. Owning a large number of stocks in the same industry is not being diversified. FURTHERMORE, one should also have some bonds in their portfolio, for an extra level of safety and to be truly diversified.
2.   Picking Winners – By owning more stocks you greatly increase your chances of picking the winners (whether you know what you’re doing or not doesn’t really matter). By picking the winners there is a greater chance that your portfolio will increase in value, and that these winners will offset any losers that are in the portfolio.

1.   Reduced Gains – for the enterprising investor who has a strong understanding of business and stocks should diversify less so as to increase the gains that are returned to him. By being diversified not only do you pick winners you also pick stocks that may not perform as well as others. This will actually decrease the amount that could have been owed to you as stocks that perform poorly will dilute the success of stocks that show a greater performance.
2.   More Time and Effort – By not being diversified you must be willing to put in the time and effort into researching stocks. If you are not going to do this and are just going to pick stocks by guessing or basing valuations of companies by the price of their stock, then you definitely need to diversify. However, if you’re doing your homework, you can diversify much less.

NOTE: Not diversifying does not mean that the level of risk increases.  It simply means that you must put more time and effort into the stocks you choose.

Personally I am against large diversification. It dilutes the gains that I could have made, and there are too many people out there who simply throw the word “diversification” around to convince their customers that their investments are safe. I believe that there are too many Investment Advisors out there today don’t really know what they are doing, so they tell people “Pick X, Y, Z, P, and Q because I don’t really know what I’m doing. So if X and Y go down P and Q should go up, and vice versa. Oh and Z is there in case all the other ones fail.” If I wanted to gamble I would go to a casino.

If we also look at some of the richest people in the world (Warren Buffet, Bill Gates etc.) we see that their holdings are not diversified. The majority of the stock that they own is in their respective companies. That is a large reason to why they are wealthy.
In sum, diversification can provide a larger degree of safety, but one should still learn everything about the stocks that they are investing in before they give the go-ahead. It should be used only if you are not an enterprising investor and do not have the time or effort to put into your portfolio. However, if you want to be wealthy, I advise against diversification. You’re definitely going to have to do your homework though.

Thanks for reading! I’m still searching for another good stock to write about, so stay tuned for that!

Oh and feel free to follow me on twitter!  Just search for Justin Gruenthaler! I promise that I’m not one of those spamers lol.