Everywhere you go, when people talk about investing or really financial planning, you will hear that you need to diversify. In fact, the Chappelle’s Show did a spoof about it with Wu-Tang financial, where a group of investors are told to “diversify their bonds”. While this is a somewhat amusing example, it highlights the lack of understanding of what diversification is.
We have all heard the phrase, “buy a diversified basket of many stocks” and you’ll be well on your way to retirement. Unfortunately, this often causes people to assume that if they are diversified enough, they will be able to avoid the pitfalls of investing in the financial markets. Nothing could be further from the truth, as is evidenced by the fall of the stock and bond markets in 2008.
Nearly every asset class moved in lockstep, and diversification didn’t end up helping people who held thousands of stocks. Of course it has since rebounded, but being where you were ten years ago is small consolation.
I submit that diversification only keeps you from losing what you have (and maybe a little extra), it doesn’t help you grow your wealth. However, diversification is used as the justification of most portfolio management. For people who are attempting to grow their wealth, to people who are trying to keep it.
Clearly, most wealthy people got that way because of lack of diversification. Bill Gates is the biggest example. Steve Jobs is another. But even Carlos Slim (richest man in the world) gained his wealth with concentration in one area. But let’s look at it on a smaller level. Most self-made millionaires generally got that way from business ownership. Sure you can be a corporate executive, but if you don’t have the right pedigree, this is unlikely to happen to most people. CEO make a very minute portion of wealthy individuals.
Of course, concentration carries it’s own risks (some big ones!). But that’s the subject of another post. Sometime. Or maybe you’ll have to wait for the book to come out.