I am sure when you come across investing, there is a quote not to "Put all your eggs in one basket". People are always encouraged to diversify to spread risk. There is nothing wrong about diversifying but at times some misconceptions and interpretations has put a different meaning to diversifying which makes it wrong. So here a bit of information to clear to confusion.
A "normal" portfolio normally consists of investments of different risk. The higher risk would usually be equities, medium risk to be real estate and precious metals, and the very low risk investments are the ones consisting of term deposits, bonds and treasury notes.
There is no ideal percentage we should allocate to high, medium or low risk investments. But we SHOULD have all. Over the long run, equities might give you the best returns, but its not sound to be holding too much of them as cash flow might be a problem.
Back to the main topic, diversifying. The lesson of the day is "DO NOT DIVERSIFY FOR THE SAKE OF DIVERSIFYING!!". I have come across people going into the stock market and trying to create a portfolio of companies from different industries. They buy companies from different industries to diversify. I have no right to say that it is wrong or less profitable. But I won't recommend people diversifying like this unless it is really sound to do so.
A quote from Buffett says " DO NOT DIVERSIFY". Does it put all your money into equity? Or does it mean buy only 1 stock? Okay, here is what it really means. He is not meaning absolutely don't diversify at all, he is trying to say don't try to diversify just because the rule of the thumb says so. Why?? "When you diversify, you will put money in average investments and leaving not enough money into the good investments".This ends up showing a mediocre return. Buffet owns a porfolio ranging from financials, insurance, energy to staples. He is diversifying isn't he? Yes he is, based on his diversified portfolio. So is that contradicting? NO. He diversifies based on his thorough analysis on companies he understands and believes will outperform the rest.
Having said that, had he diversified into technology in his early days like Microsoft, he would be making a much bigger return. But till today, he tells people he doesn't understand technology and still stands by it. I think its a pretty good example to follow.
I hope I have cleared some confusion about diversification. So the next time someone tells you to diversify your portfolio through some form of investment, please remember it isn't necessary going to be good or reduces your risk. It could just mean you own a different "type" of investment and thus giving you a diversified portfolio.
Diversify your portfolio the right way
~deyao~
