Diversification or ‘Don't put all your eggs in one basket’

srcandas

Just a weekend chat if you want to join in :cool:

I’ve been thinking about this and I think it is easy to get mislead when talking about portfolio diversification.

Looking at extremes to give some context:

• If you totally diversify you in effect have a portfolio that tracks the world. For sure you have limited your risk but have you also not stifled any chance of a profit??
• If you put your entire wealth plus deferred mortgage into an African gold mine you could end up bankrupt or rolling in it.

Back to earth:

Recently there have been a number of posts showing portfolios of from ten to 30+ funds, ITs ,etc. If you look at the constituent parts of each fund you are looking at potentially a thousand+ individual investments. And of course as most have some flexibility on when to enter and leave each fund the time axis further reduces risk (a type of diversification in it’s own right).

Clearly the industry likes to promote such diversification. Creates much greater opportunity to milk costs.

So should us DIYerselfers be looking for greater focus? Backing our hunches and if necessary allowing the cyclic process to reduce our risk :beer:

jamesd

Buying a world tracker doesn't eliminate a chance of profit, it eliminates any chance of doing better than the whole market. Concentration increases the chance of beating the whole market but at the cost of higher risk (not just volatility, actual risk of loss) and volatility.

For some markets it's completely impractical for an individual of normal means to participate. Try finding an efficient way to buy small cap companies worldwide and to get cost-effective financial details of Azerbaijani small cap mining companies, say.

For each person there's a particular balance that they can strike between some portion that may get average results and some that may or may not do better.

There are a few key things that can be done that help whatever approach is used:

1. Learn to buy low and sell high instead of the other way around. The sell part of this is the hardest one, the buy is also hard, but not as hard.

2. Learn that small caps deliver better long term performance with greater volatility. In general.

3. Look at demographics and what that causes in the markets where people are young and investing or aging and disinvesting. Be cautious about disinvestment markets like Japan, because there's a constant selling pressure from the disinvestment. The UK boomers are retiring now, putting some downward pressure on the UK. The US is starting to follow the UK but has more immigration to produce more investors and help to reduce the effect.

4. Decide whether you want to guarantee underperforming the market with a tracker or want to try to do better. On average people won't, but you don't have to pick overpriced dog funds that those with limited choice may be stuck with, or trackers.

5. Leverage is good. If you know how to use it.

6. Borrowing more generally is good, if the price is right compared to what you will do with the money. If the price is wrong, don't.

7. You can only be a forced seller, not a forced buyer. Be patient and be sure you have the reserves so you aren't a forced seller at a bad time.

8. Find what works for you and do it. Stop doing what doesn't work for you. We're all different and there's more than one way to make money. Debates can sometimes be interesting but so is accepting the many ways to profit and respecting those using different ways.

sabretoothtigger

srcandas wrote: »

age into an African gold mine you could end up bankrupt or rolling in it.


Clearly the industry likes to promote such diversification. Creates much greater opportunity to milk costs.

So should us DIYerselfers be looking for greater focus? Backing our hunches and if necessary allowing the cyclic process to reduce our risk :beer:

Just noticed Russia report its reserves, I wonder if they are diversified. 10% is the typical personal allocation but for a country I think its higher

Russia July 1 Gold Reserve 29.5M Troy Ounces, Up On Month
By Grigori Gerenstein

Special to DOW JONES NEWSWIRES

MOSCOW--Russia gold reserve on July 1 stood at 29.5 million Troy ounces (917.45 metric tons), compared with 29.3 million Troy ounces (911.23 tons) on June 1 this year, the Central Bank of Russia reported Friday.

The value of Russia's gold reserve increased in the course of June by 2.3% to $46.325 billion, following the world gold price.

Russia's gold reserve on Jan. 1 stood at 28.4 million Troy ounces (883.2 metric tons), compared with 25.4 million Troy ounces (789.9 tons) on Jan. 1 2011, thus increasing by 11.8% in the course of 2011.

The value of Russia's gold reserve on Jan. 1 increased to $44.697 billion from $35.788 billion on Jan. 1 2011.

Russia's gold reserve increased in the course of 2010 by 24.9% to 25.4 million Troy ounces. Russia's gold reserve in money terms increased in the course of 2010 to $35.788 billion from $22.798 billion.

July 20, 2012 09:37 ET (13:37 GMT)

Just being broadly balanced is ok, no need to take it to extremes

Reaper

I think it is possible to be over-diversified. If you have loads of funds covering the same market you can expect to end up with average performance in which case a tracker would do much the same job at less cost.

Likewise if you cover every country/market. While it is good to have wide coverage I would always have a bias to favour of the ones I expect to do the best.

Jegersmart

Yes, I have raised this point a few times before. Diversification can be desirable at certain times, but the reverse is also very much the case. Everyone has to decide what they are comfortable with.

J

grey_gym_sock

you have decide whether you have opinion that you want to bet money on. if you don't, diversification is the alternative: put a small bet on every horse. there's no requirement to have an opinion about everything.

i think new investors tend jump to the conclusion that sector X or country Y is a good bet, when the answer is often: yes, it has relatively good prospects, but that information is already in the price (it's already gone up), so it's not at all obvious whether you'll do well if you buy in now.

Chargem

Interesting discussion. Do you think diversification by asset class or by geography is more important?

If you had to choose a portfolio of different asset classes in the same country (gilts, UK shares, UK property etc), or a portfolio of the same asset class globally diversified (e.g US, UK, EM, Euro and Asia shares only), which would you choose?

sabretoothtigger

by political risk might bridge both since countries invest in each other.
UK is one of the largest holders of USA debt hence people almost always over invest in western equity Im pretty sure.
USA poorer means we are poorer, no need to double up on that

Linton

Chargem wrote: »

Interesting discussion. Do you think diversification by asset class or by geography is more important?

If you had to choose a portfolio of different asset classes in the same country (gilts, UK shares, UK property etc), or a portfolio of the same asset class globally diversified (e.g US, UK, EM, Euro and Asia shares only), which would you choose?

I think your final question is too simplistic.

If you are investing in global oil companies I dont see geography makes much difference at all.

On the other hand by investing in different geographies you are to some extent investing in different types of assets - eg invest in the UK you dont get much manufacturing or electronics. Invest in the Far East you get a smaller % of financials. Investing in Australia is mainly investing in commodities.

Taking another example, high risk bonds will tend to follow the equity market: in bad times high risk companies go bust.
On the other hand low risk bonds (eg gilts) tend to perform oppositely to equity: in bad times such bonds are seen as a safe haven.

So the important thing is to analyse your diversification in terms of correlation.

Going back to your original question, if you are talking about investing in major markets, asset class is generally much more important than geography simply because the major markets mainly operate in a global economy. Though those asset classes for which geography is an important factor - ie property - would be to some extent a counter example.

MrMalkin

Linton wrote: »

So the important thing is to analyse your diversification in terms of correlation.

A thousand times this. The point of diversification is that not to spread your investments geographically, but to gather enough uncorrelated assets so that when part of your portfolio dips, the rest of it doesn't.

For instance - and I will put the caveat in that I don't necessarily recommend this approach to anyone - an American called Harry Brown developed the Permanent Portfolio, which consists of 25% (US) Equities, 25% (US) Bonds, 25% Cash, 25% gold. All assets with very little correlation to each other. And as a result, over the last couple of decades and all of the economic ups and downs we've experienced, this portfolio has delivered superior returns to any of the its individual components in isolation.

DiggerUK

When there is boom and bubble, the mantra of diversification is not challenged because most of the portfolio investments suck on the profit bubble, and make good returns.
So the diversification produces high, or very high returns, with the elements in the portfolio due to the boom and bubble, not because of it's diversification.

What most still do not accept, is that the bust is well and truly here, and the old ways do not work.
An understanding of what is really going on in the world, and the world of economics, is far more use than some diversification plan.

If you do put your eggs in one basket, then do as the man said....don't take your eyes off the basket
..._