Thatstockguy.NET--Diversification and its impact on portfolio asset allocations and Warren Buffet's thoughts

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WARREN BUFFET DOESN’T DIVERSIFY, SO WHY SHOULD YOU?
2/7/2009

WRITER: SIMON GIANNAKIS

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Intended Audience
Personal investors managing their own investment portfolio and who are looking into how the theme of “diversification” will impact their investment decisions.

Summary Points to Take Away
(1) By following many industries, you make it hard on yourself to develop an edge, which is needed to compete with investment professionals.

(2) Throughout our lives we’re encouraged to specialize when it comes to our career. Why doesn’t the same logic apply to the field of investing? Why would a doctor invest in a silver mining operation over medical companies? Isn’t that doctor’s expertise in the field of medicine?

(3) Diversification brings you to the point where your investment portfolio is merely a stock index; thus, just save yourself the time and purchase index funds instead.

(4) Even famed investor Warren Buffett is against diversification.

Analysis
This article is a look into one of the most traditional pieces of investment advice – “diversification”, and whether to incorporate this stategy in the formulation of your investment portfolio.

Stock prices are made up of the aggregate value estimates that the global investment community places on the stock. In order for a personal investor to be successful, they’ll need to develop an edge in order to earn above market returns. By focusing on all sectors, an inventor effectively ends up specializing in nothing; therefore, never develops an edge. Look for your niche and become a specialist in that area (i.e. if you’re a doctor, focus on medical companies and not silver mining operations or clothing retailers, focus on the area where you know more than the average investor).

All our lives, we’re told from a career standpoint to work on a specialty (niche) and become an expert in that field. Why doesn’t the same apply to investing? You wouldn’t expect an expert dentist to also take up careers in construction or coaching hockey, would you? So ensure you stay without your realm of comfort and don’t invest in areas you don’t understand just for the sake of diversification.

The more you diversify your portfolio, the greater chance the portfolio’s returns will imitate that of an index fund. Might as well save yourself the time and effort required in maintaining your investment portfolio and just buy index funds.

Even famed investor Warren Buffett is against diversification, “diversification is a protection against ignorance – not required for those who know what they’re doing.” His advice is to “put all your eggs in one basket and watch it carefully”. He doesn’t look at portfolio correlation or care whether he already has a different position within that sector – he simply buys undervalued businesses, period.

Where to go from here?
When analyzing stocks to add to your investment portfolio, just focus on the actual stock and not whether it’ll keep your portoflio diversified. Focusing on diversification could lead to overlooking profitable opportunities or taking on less favorable stocks, just to keep your portfolio diversified.

Would love to hear your feedback, contact thatstockguy.NET@gmail.com.

Thanks,

Simon

Simon Giannakis is the founder and creator of www.thatstockguy.NET . He is a Senior Accountant within the Assurance and Advisory group at an international public accounting firm in Toronto, Ontario. Simon is a Chartered Accountant and currently pursuing his CFA designation. Simon can be contacted through thatstockguy.net@gmail.com .