Diversification is a widely used investment strategy amongst investors who want to reduce their risks while also increasing returns. This usually happens through acquiring a cocktail of asset classes, across different markets or sectors.
The most beneficial thing about it is that the impact of any single downturn or loss will be minimal. And exposure to multiple markets greatly increases the overall performance of the investment, especially in terms of growth and income.
I believe there are times when diversification is not suitable. Depending on our financial goals, time horizon and situation, diversifying too early or too much may not be the best option. In many cases, it may even hurt our investment viability.
This is the ability of an investment to generate enough returns to cover both its costs and risks and also contribute to the overall growth. An investment in which the gains are more than the losses overall is viable. If the losses are greater than the gains then it is not viable.
Reasons Why Diversifying Too Early May Not Be Viable
If someone has a well thought out investment thesis, coupled with a strong conviction and a long-term view, then diversifying too early isn't the way to approach investing.
This said person could be better off investing in a few high-quality assets that match his/her investment thesis.
For example, I'm mostly bullish on the technology sector and have a basic understanding of it. My thesis is that it is a huge value provider in a sense that it creates solutions to solve the many problems in the world. So it's overall value will keep increasing over time.
If I'm investing in that domain, it would be much preferable to invest in a handful of leading tech projects that have strong competitive advantages, than spreading my funds across dozens of other tech projects that may not do well.
The reason being that it's always preferable to take a few big bets than many small bets. With diversifying too early, one will hinder the growth of the primary investment(s) and also miss out on higher returns from a focused portfolio.
For certain investors, diversification can get overwhelming and time-consuming. This is truer for new investors who haven't got sufficient knowledge about investing. Because of that, one may face more complexity and confusion from diversifying.
It may be harder to monitor and manage all the investments. Keeping track of the performance, risks, and possible correlations of various assets in different markets and regions could also be a hard task. There's also the possibility of incurring higher costs and fees from diversifying.
For me, this one is not only inviable from an investment perspective, but also in a rational perspective. There's not much sense in embracing this complexity on the journey of investing, especially in the early stages. Yet many people(myself included) fall into it unknowningly.
When And How To Diversify Strategically
Of course, I'm not implying that diversification is unneeded. It can be a good tool in some occasions. When one is investing for retirement, then diversification could be the way to go as it is an 'over time' basis.
The key is to diversify intentionally and strategically, rather than for the sake of it. We could learn to diversify only when it makes sense for our situation or objectives. And only to the extent that it brings value to our portfolio.
Since it is a dynamic investment market, it will be beneficial to review and adjust the diversification strategy routinely. This helps ensure that it remains relevant and effective.
Diversification is not a silver bullet that guarantees success. At the core of it, is a trade-off that involves giving up some potential upside for some downside protection.
Which to give up or protect will depend on individual circumstance or preference. But before deciding to diversify or not, we could first ask the question; is it viable for me?
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