iversification is an important concept in investing. There are different forms of diversification and besides investing, diversification is also applicable to many common situations in our lives:
- We may eat different foods to get variety of healthy nutrients
- We may perform different types of exercises to make all parts of our bodies fit
- We may use different kinds of transportation to efficiently reach various destinations
- We may own all kinds of clothes and shoes to cover every possible weather or occasion
I even know of a family where mom and dad never travel together in the same car, just in case there is an accident… Talking about real “life” diversification.
Thus we can find examples of diversification in all sorts of our daily routines. From the investing perspective, there are at least two good reasons why diversification became quite popular among wide range of investors:
- Diversification is easy to apply
- Diversification solves the problem of lack of deep investing knowledge
While first reason is quite straightforward, the second reason may have caught you by surprise.
efore the days of Internet, investing was not available to almost everyone like it is today. The segment of investors back then was rather limited. Investing was reserved only for those who had large sums of capital or access to deep investing knowledge or both.
As the technology developed over the last 2-3 decades, markets became accessible to anyone who had even the slightest inclination towards investing. At the same time, many innovative investing products were introduced that exponentially increased the attractiveness of investing, although the complexity was increased as well.
Ordinary individuals, even those who were interested in investing, had a hard time keeping up with all the developments. They generally lacked the time to evaluate all alternatives and thus lacked the investing knowledge to successfully participate in the markets.
On top of those who already had interest in investing, various governmental schemes, like Individual Retirement Accounts (IRAs) in the United States or Superannuation in Australia, pushed whole segments of hard working people into investors. Most of them didn’t even have the slightest clue of how investing worked, yet they were tasked to select suitable funds to invest for their retirement.
uddenly, new segment of people started participating in investing yet they knew very little or nothing of what they needed to do and how to do it. Diversification was their savior!
Diversification meant they could have picked “a little bit of everything” and thus fared rather well at the end of the day in terms of their investing performance. Basically, their investing accounts closely tracked the overall market’s performance. They never outperformed the market, but they didn’t underperform it either. That was an excellent outcome considering they didn’t have almost any investing knowledge or any specific insights.
Just to be clear – there is nothing wrong with lack of investing knowledge – not everyone has the time and interest to do the investing homework. Yet that doesn’t mean they should be disqualified from participating in investing game or achieving decent investment returns.
Thus, diversification became an extremely practical solution for majority of inexperienced investors. Thanks to diversification, they could be invested in the market and yet not be exposed to enormous risks stemming from lack of their investing experience.
iversification was never meant to be an all-powerful investing technique. Actually, diversification is just another tool that you can apply in your investing. Just as every tool has its advantages and disadvantages, so does the diversification. You also need to know when, where and how to apply it, which in case of diversification, it is not difficult to figure out.
However, diversification is not mandatory. Those who want to apply the opposite approach and focus on individual investments can certainly make that choice. The rewards of focused investing can be extraordinary – and so do the losses. Applying proper alternative risk management techniques can render diversification unnecessary or redundant.
In Solid Wealth Strategy, we apply diversification where we find it beneficial. On top of that, we heavily rely on a special form of diversification that is so uncommon that you would never tell it was diversification at all. For now, we’ll leave it at that…
At the end, just take note that we favor diversification and we recognize it as an important concept in investing.
