Is stock diversification really a good strategy?
Every time the market begins to rise the question that comes under intense discussion is the topic of sector investing and which sector is likely to perform best in the future.
So, why is this?
Because investors are told that they need to buy into different sectors to reduce their risk in order to achieve good returns.
Based on this philosophy, it is about investing in areas that counterbalance those that are likely to underperform, or in other words, when one sector is going down another will go up to balance out the portfolio.
While this may seem like great advice on the surface, when talking to investors who follow this strategy, they claim that while they can achieve good returns in the short term, they achieve very poor to average returns, at best, over any ten year period.
So, this begs the question as to who this type of investing really works well for.
While it’s likely that this form of portfolio construction benefits the industry, it is not very beneficial for investors as they typically end up holding 25 to 40 stocks in their portfolio.
When I see over diversified portfolios like this, it is very common to find that one third of the portfolio is rising while the remaining stocks are going down or sideways.
I refer to this as 'diworsification', given that a portfolio that is over diversified is exposed almost exclusively to market risk, which is why many investors end up achieving very mediocre returns.
In my opinion, you should spend less time worrying about which sector to invest in and spend more time looking for good stocks, because smart investing is about buying what goes up and selling what goes down.
Dale Gillham is Chief Analyst at Wealth Within and international bestselling author of How to Beat the Managed Funds by 20%. He is also the author of the award-winning book Accelerate Your Wealth—It’s Your Money, Your Choice, which is available in book stores and online at www.wealthwithin.com.au
S3 Consortium Pty Ltd (CAR No.433913) is a corporate authorised representative of LeMessurier Securities Pty Ltd (AFSL No. 296877). The information contained in this article is general information only. Any advice is general advice only. Neither your personal objectives, financial situation nor needs have been taken into consideration. Accordingly you should consider how appropriate the advice (if any) is to those objectives, financial situation and needs, before acting on the advice.
Conflict of Interest Notice
S3 Consortium Pty Ltd does and seeks to do business with companies featured in its articles. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this article. Investors should consider this article as only a single factor in making any investment decision. The publishers of this article also wish to disclose that they may hold this stock in their portfolios and that any decision to purchase this stock should be done so after the purchaser has made their own inquires as to the validity of any information in this article.
The information contained in this article is current at the finalised date. The information contained in this article is based on sources reasonably considered to be reliable by S3 Consortium Pty Ltd, and available in the public domain. No “insider information” is ever sourced, disclosed or used by S3 Consortium.