Why You Shouldn’t Diversify Your Investment Portfolio
“Don’t put all your eggs in one basket,” they say.
There’s a lot of truth to that.
Diversifying your investment portfolio is seen as a way to minimize risk by spreading your investments across multiple assets and asset classes.
And it’s easier than ever to diversify, especially within a stock portfolio. With low cost ETFs, you can buy fractional shares in thousands of companies with a few clicks (and minimal fees).
However, there are also valid arguments for why you might not want to diversify your portfolio.
Lower Potential Returns
When you diversify, you lower your risk of a big loser dragging down your overall portfolio returns.
But that works the other way around too: you won’t benefit from a disproportionately large winner as much.
While diversification can help to mitigate the impact of volatility and market downturns, it can also dilute the potential returns of your top-performing investments.
In some cases, a concentrated portfolio of high-quality investments may outperform a diversified portfolio.
This is especially true if you have the knowledge and expertise to carefully select and manage your investments (though that is easier said than done…).
It’s worth noting that there are also potential downsides to a concentrated portfolio.
If one of your investments underperforms or experiences a significant loss, it can have a significant impact on your overall portfolio.
This is especially true if you have a large percentage of your assets invested in a single stock or sector.
Deep vs. Wide
“Going wide” refers to a more diversified approach to investing, where an investor spreads his or her money across a wide range of industries, sectors, and asset classes. This approach aims to minimize risk by not putting all of an investor’s eggs in one basket.
Going wide can involve investing in a larger number of companies, or using investment products like index funds to achieve widespread diversification.
Conversely, “going deep” might refer to focusing on a specific industry or sector and investing heavily in a small number of companies within that sector.
This approach involves thoroughly researching and analyzing the companies an investor is interested in, and then making big bets on those specific assets.
In other words, you’re “going deep.”
If you’re particularly interested in a certain type of asset, or if you have specialized knowledge in a specific industry, going deep might be a lucrative strategy.
Put another way, you’re leveraging your circle of competency to the max. You’re investing far more into what you’re most knowledgeable and most comfortable in.
That can give you a distinct advantage.
It’s the opposite of “di-worsification,” as Peter Lynch might put it. Di-worsification is more likely to occur when you invest in lots of things that you don’t really know about when you could instead double down on what you already do best.
But going deep is a lot to manage, so it’s not for everyone.
It’s important to consider your personal investment goals and risk tolerance when deciding whether or not to diversify your portfolio.
I don’t just say that as a cop out. It matters a lot here.
If you have a long-term investment horizon and a high-risk tolerance, a highly diversified portfolio may not be the best idea.
Similarly, if you already have a huge portfolio and want to lower your overall portfolio risk, maybe heavy diversification is the best option for you.
Ultimately, it comes down to your risk tolerance and what you’re trying to do. There’s no one-size-fits-all approach here.
When Diversifying Doesn’t Make Sense
While diversification can be a valuable risk management tool, it’s important to carefully consider all the pros and cons before making a decision.
Every decision has a cost.
What might make sense for most might not make sense for you. And vice-versa.
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