This is not a
definitive list but simply some key points for your consideration.
If you listen to
or read the money managers in the various general media outlets and try to
follow their advice then you will find yourself investing in everything! Do you think that is necessary? I sure don’t.
It’s not practical either.
Your initial ideas
of investing likely included investing mutual funds, stocks, bonds and real
estate. As your research expanded, you
probably learned about commodities like gold and silver. That realization expanded your knowledge to
include other precious metals, rare earth metals, pork bellies, orange juice,
coffee, wheat, etc.. Whoa! That may have
seemed a bit to exotic and overwhelming for you, so you went back to deciding
right? There are T-Bills, commercial
paper, government and corporate bonds.
Seems simple. Did you include the
high yield category and having to decide what duration of bonds you need? And of course there are still convertibles to
So now you’re
thinking you’ll stick to just stocks and mutual funds. Ok, but of course your research will guide
you to include large, mid and small caps.
Then you’ll need to make sure you cover of the various sectors; consumer
discretionary, consumer staples, energy, financials, health care etc..
And last but not
least, you’ll be told to diversify away currency risk.
In case your
thinking it’s all to confusing and you’ll do nothing and be safe, think
again. There is always inflation
risk. Ignoring inflation will make
certain that you will have less later than what you have now.
While I have just
provided you with a broad list of choices and corresponding risks, it is by no
means all-inclusive. It does illustrate
that you need to make some decisions.
Since you can’t cover all the choices I suggest that you construct a
simple portfolio that you can understand, have the time to monitor and lets you
It’s right to
diversify your investments, because if you only hold one investment and it
turns out poorly then you are in big
trouble. If that poor investment is only
one of several then it becomes less troublesome and less of a serious concern
to your total portfolio performance. No
matter how much research and analysis is done, you can’t be completely certain
of any one single investment turning out favorably and statistics show that
everyone is bound to end up with the occasional underperformer in their
portfolio. If Warren
Buffet and Charlie Munger
have bought some stinkers then the rest of us are likely to buy some not so
great investments as well.
So how much
diversification is the right amount?
That depends. A terribly safe answer, isn’t it? In my humble opinion, the amount only depends
on your level
of comfort and confidence in your investments.
It is a fact that
the lower the number of investments you have in your portfolio the more
volatile it is likely to be. However,
volatility is not necessarily a bad thing.
Buffet, in many of his letters to
shareholders has frequently stated “I
would much rather earn a lumpy 15% over time than a smooth 12%”. If you are confident in your purchases then
the dips present a nice buying opportunity.
Besides, volatility is only the measure of the movement of a security’s
quoted price, not its actual value. And
if you are holding a stock for the income that it generates for you then the
price movement of that stock should concern you even less.
Benjamin Graham said that you should have a minimum of ten
and a maximum of perhaps thirty common stocks in your portfolio. Consensus amongst modern finance authors and
instructors is that the majority of market
risk is diversified at a level of approximately twenty holdings and that
anything over forty holdings provides no measurable benefit regarding
diversification. There is much written
on this subject but despite the all efforts there is no definitive answer.
I would suggest to
you that the answer depends on several factors including; the size of your
portfolio, your comfort level concerning volatility, the amount of time and
ability you have for research and monitoring of investments as well as the
level of confidence you have in your investments.
But does that mean
that any more is counterproductive? Does
that mean that less is irresponsible?
There are valid
points in the debate over diversification.
There are some, like Philip A. Fisher, another extremely successful and highly
regarded investor, that believe that you should not have more than about 10
investments in your portfolio for some very sound reasons. One main argument is that Mr. Fisher
believes investors use diversification as an attempt to cover up their level of
guesswork in constructing their portfolios.
The argument is that an investor should be more thorough and rational in
his/her decision and only invest when they are completely confident in the
quality of the investment. Once the
investor is confident in the prospects of the investment, he/she should invest
heavily in the few investments that they are so confident about rather than
sprinkle their funds over a larger number of investments that they are guessing
about. Mr. Fisher
strongly believes that large diversification is a sign of incompetence. Warren
Buffet’s long time partner Charlie Munger,
concurs by investing in a concentration of well-chosen holdings that he knows
very well. Charlie
has on occasion stated that the quantity of an investor’s holdings rises in
proportion with his/her level of uncertainty and incompetence.
The time argument
is one of a fairly practical nature; it is increasingly more difficult and time
consuming to properly learn about the business of each company, monitor their
operations and evaluate their performance and valuation as you include more and
more companies in your portfolio.
As a polar
opposite example, Peter
Lynch, a famous and successful
mutual fund manager at Fidelity Investments, managed his fund to an average
annual return of 29.2% from 1977 to 1990.
When he resigned, his fund had over 1000 individual positions.
that you can’t diversify all risk and nor do you want to. The risk you should take on is that of any
other business owner, since your investment has now made you a part owner of
seemingly obvious point about diversification must be mentioned. Simply having a large number of investments
does not provide you with adequate diversification. If an investor has holdings in thirty-two
clothing store chains then, despite the number of holdings, they are not
adequately diversified. Diversification
means not only holding investments in a broad number of investments but also
that those investments are from a broad range of different industries. Most investors are aware of the fact that
different industries perform better at different times and so it would benefit
you to hold a range of investments across a number of industries at any given
time. This will allow you to benefit
from these favorable conditions when they arise. So if you know someone who has six mutual funds
and they are all invested in USA Blue Chip equities then you can confidently
explain to then that they are not properly diversified and wisely recommend they
should have a look at one of Helden Wealth’s services at www.heldenwealth.com
to address the problem and save money too. What a
brilliant and shameless plug!
So what should an
intelligent investor do? Do what you’re
comfortable with. The central point is
that you don’t need to (and you physically can’t) invest in everything. When you read the attached copy of “The
Superinvestors of Graham and Doddsville”, you will have excellent guidance to
And from the
Theory of Diversification
is a close logical connection between the concept of a safety margin and the
principle of diversification. One is
correlative with the other. Even with a
margin in the investor’s favor, an individual security may work out badly. For the margin guarantees only that he has a
better chance for profit than for loss – not that loss is impossible. But as the number of such commitments is
increased the more certain does it become that the aggregate of the profits
will exceed the aggregate of the losses.
That is the simple basis of the insurance underwriting business.
is an established tenet of conservative investment. By accepting it so universally, investors are
really demonstrating their acceptance of the margin of safety principle, to
which diversification is the companion.
This point may be made more colorful by a reference to the arithmetic of
roulette. If a man bets $1 on a single
number, he is paid $35 profit when he wins – but the chances are 37 to 1 that
he will lose. He has a “negative margin
of safety”. In his case, diversification
is foolish. The more numbers he bets on,
the smaller his chances of ending with a profit. If he regularly bets $1 on every number
(including 0 and 00), he is certain to lose $2 on each turn of the wheel. But suppose the winner received $39 profit
instead of $31. Then he would have a
small but important margin of safety.
Therefore, the more numbers he wagers on, the better his chances of
gain. And he could be certain of winning
$2 on every spin by simply betting $1 each on all the numbers. '
The Intelligent Investor, Benjamin Graham