Friday, 24 April 2015

Diversify OR Not?

I am serving my In-Camp-Training (ICT) this few weeks. For me, ICT is always a time to take a breather from work, where camp mates get together to "talk cock sing song" aside from the military duties on our shoulders. Incidentally, I chatted to two camp mates about investments in stocks. Let’s call them camp mate Mr. A and B. Both of them salaried employees and invest as part timers currently. 

Mr. A – Only Concentrate on One to Two Stocks? 

Mr. A who is just married, told me he is planning to quit his day job soon. It has always been his aspiration to stop work as a salaried employee when he reaches age 35. Now his age the time has come. This is because not only is his age criteria fulfilled, but he had profited from the raging stock market lately. After Mr. A quit, he will devote full-time on stock market. Mr. A is neither a value investor nor a trader. “Any style, as long as it earns money!” Mr. A said with a wide and confident smile.  According to him, he only trade US stocks and normally only hold 1 to 2 stocks. His winner is "Apple!" Strategy is simple. “Just keep focusing on these 1 to 2 stocks, buy and sell, to profit from it.” I was told. 

Mr. B – Only Concentrate on One Sector 

Next up is Mr. B, a family man with two kids. While idling and checking my stock portfolio on phone, Mr. B glanced and out of curiosity, asked those are stocks portfolio. “Wah so many stocks”, he asked. “Yes, more than 20 in SGX”, I replied with a smile. On the contrary to me, Mr. B only hold few stocks, only invested on NYSE, and punt mainly on banking stocks. I then queried if it is a risky to concentrate investments on one sector. Mr. B explained without qualms that his strategy is sound. “Banking stocks are going to enjoy the uptrend when Fed raise the interest rates!” Mr. B said.    

So there you have it. Absolutely NO diversification for campmates A and B. One focus on a particular stock while another focus on a particular sector. Other similarities are; both only invest in US stocks now! Both are very confident about their strategies and none mentioned about the “What If” black swan situation. 


Diversify or Not? 

So THE Million Dollar Question, "Diversify or Not?"

Different people adopt different school of thoughts. Perhaps it is most appropriate to hear from the most successful investment gurus of all time as follows, before we decide.

Warren Buffett
“Diversification is protection against ignorance, it makes little sense for those who know what they’re doing.” 

Warren Buffett has often opposed diversification as an investment strategy, while Buffett's master - Benjamin Graham, on the other hand viewed Diversification as a key idea of achieving market beating portfolio returns.

Benjamin Graham says: 
“Diversification 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.”

Jim Rogers
“If you want to make a lot of money, resist diversification. Brokers promote the motion that everybody should diversity. But that is mainly to protect themselves. The way to get rich is to find what is good, focus on it, and concentrate your resources there.” 

Peter Lynch
Peter Lynch certainly do not subscribe to the belief of restricting investments to only few stocks. He held as many as 1400 stocks as a portfolio manager at one time. Lynch have faith that as long as few out of the many stocks becomes a multi-baggers, we will be a winner. 

However Lynch do mentioned that over-diversification can be termed di-worsification which is inefficient diversification. 

“There is no point in diversifying just for the sake of diversifying, particularly if it means less familiarity with the firms. Investors should own however many "exciting prospects" that they are able to uncover that pass all the tests of research”. 

Lynch also suggests investing in several categories of stocks as a way of spreading the downside risk. On the other hand, Lynch warns against investment in a single stock.

Rolf's Thoughts 

I am definitely no Guru like anyone of the above. I am just an average home-based conservative investor. As a non-professional, who neither have long hours gluing to the market charts, nor guts to stomach big risk, I will go with diversification to reduce my risk. Ultimately my aim is simple – to gain market index beating returns and compound.

Buffett and Jim Rogers' approach of non-diversification should work well for discerning investors like them, or other professional investors, but perhaps not everyone are like them. 

Nevertheless if you shared the same strategy with my campmates aforementioned, who are part timers, and only invest in single stock or sector, please bear in mind that when Market swing drastically in the opposite direction, things can turned sour really quickly against your favour.  

Whether which strategy is right or wrong pose little significance here. Essentially we ought to have a clear-mind of what we are doing, be responsible of our action and most important of all, know what to expect if things take a drastic turn!

So how about you? Diversify or Not? 





12 comments:

  1. Hi Rolf

    For Buffett and Rogers , they "diversify" the risks to others.

    How about retail investors ?

    ReplyDelete
    Replies
    1. Hi Small Time Investor,

      Majority of retail investors absorb the risk and diversify their earnings to many others. We just need to make sure we fall into the minority group. :-)

      Delete
  2. I diversified and then leave behind few concentrates. So how do I classified as?

    Fake orange or apple juices?

    ReplyDelete
    Replies
    1. Hi CW8888,

      I am not sure, but suddenly I feel hungry for dinner already.

      For meat selection of my meal, if I love chicken more than beef, pork, fish, seafood etc, I will eat chicken 3 days a week and rest of 4 days I split. I think it works well for me.

      Of course some people prefer eat only chicken 7 days, and some everyday change.. as long as u like and don't "Lau Sai" or be under-nutrition. More IMPT dun be a burden to those who love or close to u.

      For your meal, since u have different appetite, and owns ur body for so many years, u know best for urself. At most nutritionist can give u facts and consequences but not dictate ur food!

      Oh ya... I love orange juice, but fresh is the best, if not must be nutritious or taste good. Fake orange... maybe not for me. Apple juice occasionally is nice. Fresh also, thank u!

      :-)

      Delete
  3. Rolf,

    The question to ask is whether you 2 camp mates after discovering you are more "diversified" than them, do they start questioning their focus and concentration strategies?

    ;)

    ReplyDelete
    Replies
    1. Hi SMOL,

      Agree! What we do initially is no more important than what we do next after learning more.

      Basically Mr. B says he did not put lots of money into his stocks, so he prefer to status quo his strategy. Mr. A who wanted to turn full time spend more time educating me about stocks and I prefer to listen then. He does not know I am diversified. :)

      Delete
  4. Hi Rolf

    Many things in life and also in investing we are thinking from a binary decision point of view. A good example would be to diversify or go all on one stock, go in all cash or out of cash, etc.

    The thing about what we are doing as an action is usually vastly different from the academic thinking of the binary decision. And depending on one's objective, to diversify or not is certainly different too in the eyes of different investors.

    ReplyDelete
  5. No right or wrong in investing?

    Laughing to the bank or crying when looking at our bank statement?

    ReplyDelete
  6. Hi B,

    Yes, human beings are born with different height and size afterall. Hence all are different!

    But out of the differences, we can still classify or categorize!

    Guess, if you are not so in depth or not willing to spend too much time into investing, it is better to keep risk down. I think this is a general rule of thumb I advocate for most.

    ReplyDelete
  7. Hi CW,

    No right no wrong? I still think there is at least a general guidlines amateur must follow to mitigate risk.

    Unless the bank account statement is in the name of you, but money is not from you, then you will feel sad but not really crying.

    ReplyDelete
  8. Hi rolf,

    Have your two friends tested their strategy and survived through at least one cycle of bull /bear? If yes, then go ahead. If not, then it's still work in progress. Doesn't matter full time or part time. The market will teach people the lessons they had to learn.

    Just hope the lessons won't be too expensive..

    ReplyDelete
    Replies
    1. Hi LP,

      Agreed! You have to go thru the trough and peak to fully know what is it all about. I did not ask them as we are all adults now and it's not easy to absorb advices from non- guru like me. Maybe Peter Lynch tells them they will listen better!

      Delete