Diversification vs Concentration
Updated: Sep 19, 2021
Remember, whenever you invest, you want to grow your money. You’re making your money work for you. Don’t put all your eggs(money) in one basket, and then lose it.
Protect your investment, and make sure it is as secure as possible. But, how do we do that?
Invest using the most secure methodology.
What do you mean by secure investment methodology?
I mean, value investment plus diversification!
If you have known about investing for long enough, you cannot help but run into a company named: Enron.
Why is Enron so significant? and what does it represent?
Let's recap what happened with Enron back in 2001.
Enron, known as the 7th largest company in the US at the time, suddenly declares bankruptcy on October of 2001. It's share price at one time was as high as $90.75, plummeted to less than $1 within 2 months.
Shareholders loss billions of dollar because of the sudden declaration of bankruptcy.
In the end, what caused the bankruptcy was that Enron was involved in a series of Accounting fraud, making up fake earnings reports and exaggerating the company's revenue to boost stock price. Many of it's executives just took the money and ran away, leaving share holders to fend for themselves.
If we stay long enough in the stock market, chances are, we're going to run into company like Enron.
When we see a company that looks so prosperous and price was so reasonable, we always tempted to put every penny we have into that company's stock.
However, if that company is Enron, then we have a problem.
Without diversification, we would have loss 99% of our investments.
Invest in diverse industries, and companies not only will reduce your risk, but it'll also increase your exposure to different fields and allow you to learn more about different markets.
Keep in mind, diversification with proper concentration. Maybe 10-20 stocks is a good amount to keep in your portfolio without diluting your investments too much.
Within your investment years, maybe 1-2 of your stocks would become no longer prosperous(like Enron), but that's ok. We can just get rid of it, and buy something else. Losing 5-10% of your portfolio is not good, but it is much better than your entire principle.
"No stock is good enough for you to invest 100% of your funds into."
According to "Murphy's Law": Anything can go wrong WILL go wrong.
What Murphy means is that: "Over a long enough time, I stress the LONG ENOUGH, no matter how low a probability of something can go wrong, will go wrong.
Let me give you an example:
If ABC company have 1% chance of becoming the next Enron in 1 year, and if we invest in this company for 99 years, the probability then becomes 99% within the 99 years.
The accumulation of probability means low probability event can happen under a long enough period of time.
With that being said, it is necessary then we diversify our investment.
Another benefit of diversification is to avoid investing in an industry that is going obsolete.
In the 21th century, we've seen many industry gone obsolete.
Some of the examples are:
CD / Cassette tape
These industries are being replaced by technology rapidly.
If you are one of those unlucky investors in these industries, no matter how long you wait, you are not going to make any money.
Since we cannot foresee the future, diversification will help us reduce the chance of a total loss when our invested company has gone obsolete.