As the old adage goes, “Don’t put all of your eggs into one basket.” In the same vein, diversification borders along the idea of creating a portfolio which includes multiple investments in order to reduce risks. In theory, diversification eliminates idiosyncratic risks- risks unique to a certain company. Take for instance, when Sete Brasil, a major client of Keppel Corporation, filed for bankruptcy protection, Keppel’s share price plummeted. Or when Jurong Aromatics Corporation went bust when it couldn’t survive the commodity slump last year. Besides idiosyncratic risks, there are also sectoral risks to consider. Say, if you invest all your money into the real estate sector and the government announces property cooling measures or interest rate hikes shortly after. Your investment will be adversely affected, especially so since such government policies are sector-specific and such rate hikes have great bearing on real estate companies given their high borrowings. With such risks prevalent in the market, it is up to investors to diversify to “safeguard” themselves against the unforeseen.
However, with Warren Buffett advocating focused investing, is diversified investing really worth considering?
There are 2 school of thoughts on focused investing.
The first being that with all your money deployed into a select few, you will probably spent more time analyzing the company you are buying into as one minor mistake or a careless overlook may cost you a majority of your portfolio. With so much at stake, it compels the investor to put in the time and ample effort to ensure sound fundamentals and proper corporate leadership to take the company forward before putting faith in its share.
The other contrasting belief is that with focused investing, one will be emotionally attached to the stock and hence make their “buy” and “sell” calls based on emotions and market noises. It is said that with focused investing, one will be so “in loved” with the company he bought into that he tends to overlook screaming facts depicting impending crisis.
As with all approach, there are two sides of the argument and it is up to you to decide whether focused or diversified investing is for you. It is also important to note that Warren Buffett is a natural. He is able to identify good businesses very naturally. Despite us wanting to be a Buffett, not everyone is as gifted as he is.