When it comes to investing, there is an old saying that says, “Never put all your eggs in one basket.” I am sure you have heard of it before. But do you know what it means?
Many novice investors do not. Or they have the wrong interpretation.
Many still think that if they invest in the stock of a company with diversified businesses across different product lines or geographical continents, they have diversified their investment. This is simply flawed and not true in my opinion.
I intend to share some light on what true diversification is and hope that readers of my blog will get a better understanding of it.
The Importance of Diversification
Again, putting all your money into a diversified business is NOT diversification at all.
Remember WorldCom and Enron? Many retail investors have put all their retirement funds into these 2 companies and were hoping to go easy during their retirement years. But guess what happened to them.
These 2 companies collapsed. Their employees lost their jobs and retail investors lost all their entire savings. Many have gone bankrupt with the companies.
What about the internet dot.com bust in 2001?
Before 2001, many touted the internet as the wave of the future. Those internet companies were considered “failsafe.” Nothing can happen to them. Their stock price can only go in one direction – UP. Many investors believed that this is going to be their ride of a lifetime. As such, many investors including institutional investors poured in tons of money into these companies. Thinking they have it made.
But when the dot.com bubble burst in 2001, what happened to all the investors? Many retail investors have lost their entire savings and some institutional investors have declared bankruptcy as a way out.
So much for “diversification” in the wrong sense.
There is No Such Thing as a Sure Thing
There is no such thing as a sure thing in investing. Not Enron. Not WorldCom. Not any company.
When someone tells me “a sure thing”, I hold tight to my wallet and walk away immediately. When someone tells me, “This time it is different.” I run.
In the investing universe, the only certainty is uncertainty. No one knows how your investments will end up. Not Warren Buffett. Not Peter Lynch, Not George Soros. Those “gurus” you see in the seminar circuit who tell you they know the market well are just bullshitting to you like a bull having diarrhea.
What is True Diversification Anyway?
As mentioned in my book – 12 Fundamental Truths for Financial Wellbeing, true diversification means you want to find asset classes that do not move in the same direction at the same time in the same event. You want some of your asset classes to zig, and other asset classes to zag at the same time in the same event. However, doing so will not help you eliminate market risk completely, but it does help lower your risk to a comfortable level that you can sleep well at night. This is what true blue investors do.
Also, to truly minimize market risk is to own the WHOLE market, NOT 10, 20, or even 30 stocks from different companies in different industry sectors. And to own the whole market of about 5000 public companies in the United States alone would be cost-prohibitive for any investor to do so.
This is the reason why I invest in ETFs.
Vanguard to the Rescue
With an Equity ETF, you get to own hundreds, or thousands, or even the whole market of about 5000 individual stocks in the US, at a starting cost of a few thousand dollars only. Doing so will give you the diversification you need to sleep soundly at night.
Also, if you should add a Bond ETF to your Equity ETF, then you would have the whole world in your hands for life.
Again, ETF investing is not suitable for all. It is always wise to seek independent advice and understand the risks involved before investing.
Thank you for reading this article.
Founder & CEO, ALGOINSIGHTS PTE LTD