| Picking consistent investment winners is not an | | | | picking big winners and not have gains diluted by |
| easy task. It takes experience, time, money, | | | | offsetting loses in another part of the portfolio as |
| information, and a bit of luck. But the payoff can | | | | often happens with diversification. Of course, |
| be worth the effort; if you can consistently pick | | | | that's easy for Mr. Buffet to say because he is a |
| winners. That's the hook. Very few investors are | | | | guru. But most of us mere mortals don't have the |
| consistent winners. But through the genius of | | | | time, money or skill to become a focused |
| diversification, even the totally unknowing investor | | | | investor. Besides, those who try to become |
| has a good chance to preserve the value of their | | | | focused investors usually end up focused on a |
| capital and create wealth over time. As a matter | | | | dwindling investment account. |
| of fact, the benefits of diversification are the | | | | There is another big difference between |
| foundation for the huge investment industry that | | | | diversified and focused investing strategies: one |
| provides millions of small retail investors, owners | | | | strategy is the hare and the other (diversified) is |
| of IRAs, 401Ks and participants of other pension | | | | the turtle and all of us know how that turns out. |
| plans with the ability to passively increase wealth. | | | | If you look at the record of millions of small |
| A properly planned and implemented long-term | | | | investor turtles, the truth is well known. For |
| investment strategy can almost "guarantee" an | | | | example, if an investor were to invest just |
| eye-popping increase in wealth over time. And this | | | | $14,000 at age 25 and managed to earn an |
| is due in large part to the concept of | | | | average of an annual 12% return, that initial |
| diversification. What is diversification? | | | | $14,000 investment would turn into over a million |
| Portfolio diversification refers to mixing up your | | | | dollars by the time that person turned 65! It's a |
| investments by types and asset classes to help | | | | fact. This is due to the combination of risk-reward |
| reduce market risk. For example, different types | | | | balancing through diversified holdings and the |
| of investments might consist of small, medium | | | | power of compounding profits. Of course, to gain |
| and large companies. Different classes of assets | | | | the awesome power of compounding profits, an |
| might be a mixture of cash, stocks, bonds and | | | | investor shouldn't touch the building investment |
| commodities. The advantages of a broadly | | | | account balance. This is one of the reasons that |
| diversified portfolio are: | | | | IRAs and 401Ks are structured as they are; if |
| - One or a few poorly performing stocks do not | | | | you don't mess with the account, your |
| significantly reduce the overall portfolio | | | | investments can grow tax differed, which greatly |
| performance. | | | | helps the effects of compounding. |
| - It requires less active management, with fewer | | | | The average return for the Dow for the past 50 |
| buy and sell decisions, and attendant lower costs. | | | | years has been a bit above 12% annual return. |
| - Performance is highly correlated with broad | | | | So, with a diversified portfolio that can at least |
| indices, either market or sector, and thus does | | | | match the market index, it is highly probable that |
| well in a general up market. | | | | a long term investor can become a millionaire if |
| - Performance will be no worse than the broad | | | | they have the discipline. You don't need to be a |
| market or index. However, by using hedging | | | | guru. But you do need a disciplined investment |
| strategies, much downside risk can be offset. | | | | plan and not panic when things go poorly-as they |
| Basically, diversification means that if one part of | | | | inevitably will. Unfortunately, for one reason or |
| a diversified portfolio does poorly, it can be | | | | another, many investors can't keep their hands |
| ameliorated by other investments in the portfolio | | | | off the nest egg. |
| that do relatively better. | | | | Over the last twenty five years of portfolio |
| On the other hand, there are some gurus like | | | | management, I firmly believe that if it weren't for |
| Warren Buffett who tell investors to concentrate | | | | the grace of diversification and compounding |
| on stocks they know well. He calls this "Focused | | | | gains, most investors would have little chance to |
| Investing", which stipulates that investors place | | | | build wealth in equities. Indeed, diversification is the |
| bets on a few stocks with the expectation of | | | | only "free lunch" I know of. |