We’ve all heard it being said many times the importance of diversifying our sources of income. The reason for this diversification in our portfolios is to minimize the risk of losing it all if something bad were to happen to the company we’ve invested in or in that sector.
Diversification is a strategy that many people use but it’s especially used by the more conservative investors. Since it has a lower risk this means that rewards or return on investments will most likely be lower than the riskier investment strategies.
Examples of diversification:
1. Investing throughout different sectors of the economy like construction, retail, manufacturing, entertainment etc. Investing in different sectors will usually require widespread knowledge throughout these sectors.
It also requires you have more resources to invest and manage these assets because different sectors have different rules which are a hassle to keep up with. Although, this form of diversification is the safest one because it protects you from one sector going bad and losing it all (e.g housing crash of 2008). It does, however, create the need for third parties to manage your assets for you and stay up to date with the current regulations governing these different asset classes.
2. Another example of diversification and perhaps the most common is to invest in different asset classes within the same industry or sector. In the distributed ledger technology or cryptocurrency sector, people have the opportunity to invest in dozens of different assets.
Now with this type of strategy, there are two important facts to be aware of.
Firstly, as much as you can diversify your investments there’s more risk in this strategy than in the previous example. This is mainly because you’ve bet all your chips into one sector (cryptocurrency) in the hopes that it will thrive and not collapse in the coming years and if it did fail then you would lose all of your funds. Secondly, because there's so much competition in the space it is necessary that one does a lot of research to determine whether or not their investment has a likely chance of succeeding over competitors. Clearly, a lot more skill is needed in the long run in order to build wealth in these conditions.
The alternative
Alternatively, you have the option of doing the complete opposite of diversification and invest all your funds in one company or asset. There’s a good reason as to why you don’t hear about this investment strategy very often and that is because it is extremely risky and requires high levels of experience to see it through.
Investing in one company requires you to have patience and resilience for when things seem to be going in the wrong direction. When the investment is losing you money in the short term the worst thing you can do in such a situation is to doubt your position. For example, many people jumped ship when Amazon took a big hit during the dot com bubble burst and every company in that sector was sinking. But a couple of years later Amazon became a cash-cow for those who held on to their position.
This strategy is also known as the 'Andrew Carnegie philosophy' which is putting all your eggs in one basket and watching that basket very closely. You need to ensure that you have done your research thoroughly. When you’re highly confident and with good reasons only then can you bet it all on one horse.
If you believe the company you’ve invested in to be a big future player and will see good returns, then this could be the best strategy as diversification will only minimize your returns. People like Warren Buffett are renowned for making such investments and cashing massive cheques for their troubles. It takes a lot of practice and experience to successful pull this off and you need to know everything available about the company as if it were your own child.
There's a lot of factors that will determine which investment strategy is best for you. Your financial status, risk aversion, length of investment etc. Some people even choose their investments based on superstitious beliefs rather than logical ones. Analyze your situation before you make your move.
That's all for today folks,
Cheers!
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