Diversification – A Controversial Notion

People ask me all the time if their holdings are diversified enough. It’s probably the single most-common concern among investors: are they sufficiently protected against a net asset loss event. And like most such questions, the answers vary dramatically depending upon that individual’s situation, needs, tolerance of volatility, tolerance of risk, and level of involvement in the investment portfolio.

The concept is simple enough, and probably 95% of analysts and financial planners will tell you diversification is one of the key factors in managing the risks associated with any single investment. Just spread your invested dollars across different asset classes, different industries, market caps, global regions or even countries:

Asset classes–

• Stocks, or Equities
• Bonds, or corporate/municipal debt
• Commodities like copper, wheat, natural gas, pork bellies
• Real Estate
• Treasury bills
• Collectibles like art, vintage automobiles, sports memorabilia, fine wines, etc
• Cash, or cash equivalents

Market cap–

• Small cap (company valuation $300 million – $2 billion)
• Mid-cap  (company valuation of $2b – $10b)
• Large cap (company valuation upwards of $10b)

(For more details on the asset classes and what broad diversification would involve, read this great NerdWallet overview.)

With proper diversification, if a substantial pullback hits U.S. biotech, or South American heavy equipment manufacturing, that investment makes up a small portion of your overall portfolio so most of your money is ok. Imagine you had a big stake in light crude oil a few years ago, before prices fell over 60% globally due to a supply glut … It simply makes sense to make sure your eggs are in more than one or two baskets. 

Certainly I am diversified to a point. I own stock in a number of American companies which derive a substantial portion of their revenues from countries outside the U.S., including Amazon, Disney, and Starbucks. I own stock in some huge large-cap companies, including Apple, Google — sorry, Alphabet— and Berkshire Hathaway, as well  as some mid-cap companies like Zillow and FireEye. My smallest-cap is Imax, maker and licenser of those gigantic movie systems, but even that is a mid-cap. I have no small-cap stocks. 

Which means the bulk of my holdings are in large cap, consumer-facing businesses. I’ve got retail, automotive, insurance, banking, entertainment and social media in there, but even then most of those have a substantial tech component. So really I’m not at all diversified. Because that’s the stuff I know, the industries and the companies I follow in the news, business models I understand and companies for whom I am a customer. 

It’s a good solution, but it doesn’t work for me. Again and again I choose volatility and company-specific risk if it gets me faster growth, and I’m willing to ride the roller coaster through the big dips. I’ve studied my companies and I’ve chosen carefully. I’m patient with my holdings and encourage and nurture my portfolio as if I’m growing a bonsai tree. It works, and it’s the only way I know