Lesson and Observations – Part Two: Diversification
This post is the second in a series from guest contributor Eric Roach. Today’s topic looks at diversification from a perspective of age, overall wealth and the ability to withstand loss.
“Diversification is the protection against ignorance. It makes little sense if you know what you are doing.”
Now I might point out that like Warren, most investors with a huge net worth have in fact built their wealth with little to no diversification. Think Bill Gates, Mark Zuckerberg or even our President Elect Donald Trump.
Here is the way I look at it for most investors. Invest in as many stocks as necessary to cover the possibility of a total loss of one of your securities. Put another way, if I’m okay losing 10% from a catastrophic company loss, then I need at least ten securities in my portfolio. In my case, I’d be reluctant to go with fewer than 20, as a 5% loss is the max I think I could stomach.
Clearly, your net worth has an impact on this equation as does your age. If you are closer to retirement, I believe that more diversification makes sense. Equally, if you are young and trying to jump the void, I’d argue that a less diversified portfolio could have merit. What gets most people in trouble, is that they invest contrary to their true economic position in life.
Remember that to lose capital is far harder to recover from than that extra X percent you benefited from for taking extra risk. Invest like your life depends on it, because down the road – it will!