Diversifying

“Don’t put all your eggs in one basket” is a tag line used in many circles, especially when it comes to investing. How true is that statement?A school of thought that is popular with investors is to diversify your portfolio, so that if one particular asset suffers, your general portfolio will not be heavily hit. The whole idea of diversification is risk control.

These are some choice statements about diversification from Warren Buffett.We think diversification, as practiced generally, makes very little sense for anyone who knows what they’re doing. Diversification serves as protection against ignorance.-Warren Buffett, at Berkshire’s 1996 Annual MeetingWe diversify substantially less than most investment operations.

We might invest up to 40% of our net worth in a single security under conditions coupling an extremely high probability that our facts and reasoning are correct with a very low probability that anything could drastically change the underlying value of the investment."-Warren Buffett, 1965 letter to PartnersWe have to work extremely hard to find just a very few attractive investment situations. Such a situation by definition is one where my expectation of performance is at least ten percentage points per annum superior to the Dow.-Warren Buffett, 1965 letter to Partners

The full 1965 Letter to Partners by Warren Buffet can be read here From the investor who has made the most money in the history of the world from the stock market, this is a total reverse from the conventional train of thought. To summarise the 3 statements by Warren Buffett posted here, and books from him and Benjamin Graham, one key factor to succeed in the stock market is a high level of research and studies into the array of options, to identify the ones which are HIGHLY (close to certainty) probable to succeed.I have to admit, when it comes to personally investing in the stock market, I’m pretty much a babe in the woods.

This is because I spend my ‘education time’ on other areas and not in reading up on companies and indexes. Venturing into stocks and shares, though tempting, would be financial suicide for me.Would I be successful if I put my time into studying up companies to invest in? Then again would I trust my judgement enough to put money into that one stock? I know myself enough to reckon the answer to both would be no. That’s why I don’t work as a stock broker ;)If you purchase unit trusts or investment linked insurance products, the funds are already well diversified in the sector or region you have chosen.

My personal investment linked insurance policy (ILP) invests in 2 funds which automatically puts my money into 16 diverse sectors. If you’re thinking of investing in an ILP, consider the words from Warren Buffett before spreading out your monthly investments into many different funds. Ask your Financial Planner for a breakdown of how your money will be invested in the particular fund he has recommended to you. A person very close to me worked in the crude oil industry for 25 years, mainly as a senior oil rig engineer. During that time, he focused his investments specifically on oil based commodities and oil field companies (Chevron, BP) because he had an insight and to a certain extent, insiders information on the trends of the fuel industry. He is now happily retired. He never put a single cent in other sectors or unit trusts.To summarise, diversification has worked for some investors including a prominent local millionaire. On the other hand, the greatest investor of all time plays down the value of diversification.Should you divest when investing?

The answer would depend on your knowledge of the asset in question, and how much time and effort you are willing to put in to studying the available options. If you’re like me and don’t have the time (the want rather) to put in the necessary effort, you would perhaps be better off investing your money in vehicles that do not require personal monitoring, while keeping what you have learned in mind when making those decisions.

Extract from http://www.ihateinsurancesalesman.com