Diversification good or bad?

Discussion in 'Risk Management' started by oraclewizard77, Jan 22, 2009.

Diversification is the holy grail.

Poll closed Feb 1, 2009.
  1. Stay Diversified

    8 vote(s)
  2. Concentrate your portfolio in just a few stocks.

    2 vote(s)
  3. Stay with Cramer

    1 vote(s)
  4. Way too many polls here on ET

    0 vote(s)
  1. Too much diversification is the Noah's Ark approach. End up with two of everything and returns in the bell curve at best.

    IF you adhere to strict position sizing relative to the capital in the account, say 1% and.........IF you're willing to hold positions overnight swing trading (as opposed to daytrading), and unintended by-product is some diversification.

    Ditto for riding your winners.

    Swinging for the fences with a concentrated position or two works ............until it doesn't. Then come on here and whine about it. Blaming everyone but themselves. Scapegoats with a broadbrush generic word such as manipulation.

    This is a rigged game. Doesn't mean it can't be beat, but is rigged. In a variety of ways. The previously cited gap being just one. Unmanagable position sizes, paritucularly in llliquid instruments is "asking for it". Hurt me hurt me.

    We could delve into psychology such as greed being a denial of risk or masochistic tendicies, but it's too much typing.

    There's nothing wrong with a little diversification. As a bone us, it might acutally satisfy your craving for action.
    #11     Jan 24, 2010
  2. Good and bad are the same thing looked upon from different angles.
    #12     Jan 25, 2010
  3. diversification can also means, different countries, multiple strategies, mixed long/short, dollar neutral, etc. etc.
    #13     Jan 25, 2010
  4. If you have confirmed information about the profitability of your single good stock then sell other stocks and invest in a single good stock. Sometimes diversification results in losses. So it would be better to invest in single high profit stock.
    #14     Jan 26, 2010
  5. Studies have shown that outperforming fund managers make almost all their excess returns from their 5 biggest holdings. Buffett also ran a concentrated portfolio during his great run (until the last 10 years when he became rubbish) and would sometimes have up to 35% in a single stock if it was cheap and low risk enough. So, if you are owning stocks, it's probably best to have a minimum of 5, but not a huge amount more (maybe 10 at most).

    The other issue is market risk. Buffett lost about 45% on his investments during the 73-74 bear market, other known value investors did worse. Many of his holdings got raped from 2007-2009. It would therefore make sense to run a portfolio that isn't 100% concentrated long stocks. This could be done by fully or half hedging in index futures.

    So a concentrated portfolio that does not take insane risks might look something like this:

    #1 idea: 30%
    #2 idea: 20%
    #3 idea: 20%
    #4 idea: 15%
    #5 idea: 15%

    Index hedge: short 50%

    As long as your picks are good, in a nasty 50% bear market your loss should be around 25%, which you can withstand, and then start reducing or totally remove the hedge once the panic has hit a peak and stocks are dirt cheap.

    Alternatively just be about 50-60% long stocks, and have the rest in non-correlated assets like bonds. The trouble is that right now bonds yield bugger all so won't make much of a return in future unless we have outright deflation.
    #15     Jan 26, 2010
  6. Buffett also ran a concentrated portfolio during his great run


    Perhaps the need for concentrated portfolio to build wealth and diversification to maintain wealth. Actually this would support the premise of not to diversify when you are young. The exact opposite of the preachers selling you the time on your side theory. High risk when you are young, you have the time to recover as opposed to being the plowhorse investor.
    #16     Jan 26, 2010
  7. If you treat investing as a business almost any expansion of your business has the potential to collapse the entire company. These risks are taken everyday in business but in portfolio managment this attitude is frowned upon.
    #17     Jan 26, 2010
  8. #18     Jan 26, 2010
  9. That's an interesting point about the 7th business. I was just reading a study about face book etc and how the human brain can only handle being "friends (social contacts) with aprox 150 people regardless of how many people we know, any more and there is a breakdown. Maybe Buffet has a point with knowing 5 or 6 companies and not the 7th. Maybe he has come to that conclusion with good reason and knows the "limit".
    #19     Jan 26, 2010
  10. Having a concentrated portfolio and trading with stops is a form of diversification.... by "opportunity" rather than by "asset"
    #20     Jan 26, 2010