“The idea of excessive diversification is madness. Wide diversification, which necessarily includes investment in mediocre businesses, only guarantees ordinary results.” — Charlie Munger
Is it a good decision to diversify your investments?
A lot of people in the financial world today say you should diversify.
They think you should have a lot of different things in a lot of different places.
Hedge your bets.
Don’t put all your eggs in one basket.
Diversifying will reduce your risk.
I know a couple of investors who have invested in over 70 different passive deals.
That’s a lot of different deals to keep track of!
Warren Buffett once said: “Wide diversification is only required when investors do not understand what they are doing.”
Ouch!
That’s a tough pill to swallow.
According to Buffett himself, having a huge diversified portfolio is not a great idea.
The choice can actually hurt you.
Today, I’m going to explain more in depth why you should be wary of excessive diversification.
Let’s get into it!
1. The Appeal of Diversification
First, I will share the appeal of diversification.
It’s important to acknowledge the appeal so we can better understand the process.
Wanting to have a diversified portfolio or mutual funds can feel like a really attractive option.
When you diversify, you can limit your downside.
Let’s say you’ve got a hundred companies and one of them fails.
You’ve only lost 1% of your total worth.
That’s not so bad!
Unfortunately, there are some bad things hidden in that outcome.
Diversifying can limit your downside, but also can limit your upside.
Another advantage of diversification is there’s less correlation.
I’m invested in real estate and oil and gas.
Having both of those investments is helpful because they aren’t directly correlated, even though there is some crossover.
There are also things that are less correlated.
If one goes down, the other one won’t go down as much (or could even go up!).
If investments are more correlated, they will decrease in value at the same time.
Ideally, diversification can help you to prevent that.
Right?
2. Why Diversification Doesn’t Work
Despite all of those positives, diversification does not work.
There’s a saying that goes: “If you can’t find something to buy, buy everything.”
Usually, this line of thinking guarantees mediocre returns.
You’ll have some high flyers but you’ll also have a bunch of duds.
That averages out to pretty mediocre.
A diversified portfolio is not always as diverse as you think.
We’ve already touched upon correlated and non-correlated assets.
When crypto goes down, other similar areas go down.
We’ve seen this again and again.
If you diversify, watching everything can quickly become very difficult.
When you own a hundred companies or stocks, you can’t know everything about every investment.
You can’t follow all of their quarterly reports.
Quoting Buffett again: “Put all your eggs in one basket and watch that basket carefully.”
3. Buffett’s Allocation
Speaking of Buffet, how does he allocate his investments?
When I was an investment advisor, it was really hard to tell people how they should invest.
It really comes down to someone’s personal decision.
Buffett says all a person needs to get rich is three wonderful businesses.
He has also noted that six wonderful businesses could be all the diversification you need.
To him, the people who have 50 or 70 deals are overreaching.
You only need three or at most six.
When you have more, you can’t pay enough attention.
You have only so many investment decisions; be sure you make good ones.
Buffett has talked about this before:
If you had a card with 20 punch spots in the paper, and every buy or sell decision counted as a punch, how would you think about your investments?
You wouldn’t buy and sell stocks willy-nilly!
You would make calculated decisions.
You would be thinking long term.
This is why your financial education is one of the most important things you can do.
Invest in yourself.
Invest in learning.
Go to great events to hear about deals.
You can’t delegate those decisions
No one cares about your money the way you do.
If you have an investment advisor, that’s great!
You should still keep in mind that, in the financial world, everyone has a bias.
No one will approach your investments the way you do.
If somebody invests in one of our deals, I financially benefit.
It’s the same with just about anyone in the financial world.
You need to figure out what your financial goals are, what you’re looking to do, and how you evaluate things.
If you give that power to someone else, you’re almost ensuring you’ll have mediocre or bad results.
The focus here is to educate yourself.
Find out what your edge is.
I have an edge in real estate and medical companies because of my background.
Anything you have a passion for will give you an edge in investing.
If you take away anything today, I want you to take in the educational side of investing.
Now I want to hear from you!
What is your investing edge?
Let us know in the comments.
Before you leave, make sure to check out our special report about inflation investing. It shares the best choices to invest during an inflationary environment.
If you are interested in investing with us, we are happy to answer any questions that you may have. Join our investment club today and we will be in touch.
Disclaimer: I am not your investment advisor. This is for educational purposes only. I am not giving specific advice on what you can do. I am simply giving my opinions.
