I've talked previously about how my portfolio was heavily concentrated on the healthcare industry, so what is concentration, or rather the opposite of it; diversification?
Basically to concentrate is to put many, if not all your eggs into a single basket, on the other hand, to diversify is to not put all your eggs into a single basket.
Concentration and diversification can take place on many levels, note that for simplicity sake, I will only be talking about diversification. It is also important to understand that diversification is a term specifically applied to stocks, but can also be applied in other situations as well, but in this post, I will be talking about diversification from an investor's point of view.
(i drew this myself)
"Company" diversification
At a very specific level, an investor can diversify by spreading his investments in several companies from the same sector. For example, instead of buying stocks in a single company in the telecommunications sector (e.g. Singapore telecommunications), an investor can diversify by purchasing stocks in multiple companies in the same sector (e.g. Singapore telecommunications, StarHub and M1).
Why would you do that?
For various reasons. One reason for diversification which applies nearly in every situation would be to reduce (spread) risks. Hypothetically, if a company were to encounter operational difficulties, chances are, it is LESS likely that another company on TOP of the first also encounters these problems in the same period of time.
Basically, if you were to invest equally and hold stocks in company A, B and C, if company A's stocks were to plummet, you will be less likely to suffer a lost as significant as if you were to only hold company A's stocks.
Sometimes there is no good and available reason to make such a choice to diversify. Because as you may have probably realised, the converse can happen as well! If you were to spread your investment between company A, B and C, and if A's stocks rockets, whereas company B and C's share price stagnates, you only gain 33% of what you would have gained if you had chosen to concentrate your investment funds in company A.
Maybe the question we should all be asking ourselves is, how much are we willing to (potentially) lose (or gain?)? Maybe.
Of course our discussion above assumes that all 3 companies are exactly the same (which is an extremely unlikely scenario) in reality there may be a good or appealing reason to diversify;
For example, the companies in question may each capture different sections of the market. A random example would be Dairy Farm Holdings vs Sheng Siong. The former generally targets the more upscale market with more premium goods whereas the latter targets the value-for dollar market, even though they may both belong to the same sector - supermarket retail. Hence if you were to equally believe in the growth or stability of these companies, it will be prudent to diversify between these companies in the case of unforseen circumstances which are more often than not, uncontrollable.
One thing you may be thinking about at the moment is; "maybe I should diversify, the company I have invested in (/am thinking of investing in), has bad management, a bad track record, and it also lacks transparency". The question you should be asking yourself is; why even invest in them then? Because the charts show that there is a chance of the share prices rocketing? Well, then you may want to consider whether your goal is to invest for the long term, or gamble for a quick buck.
Ok, it seems that I have gone slightly off tangent here, so let us continue our original discussion.
"Sector" Diversification
The level of diversification; Sector Diversification is once again something to consider as well, as it also potentially reduces/spreads your risks. One reason is because different factors (or rather exposures) play a huge role in determining the success of companies in certain industries.
Some examples include:
- The banking and finance industry is exposed to a cyclical trend of the economy.
- The transport industry is exposed to regulatory risks
- The private healthcare industry is exposed to competition risks from the public healthcare sector
This is probably one of the reasons why many gurus constantly highlight the importance of diversifying between sectors and keeping track of % exposure to each sector. Something important to consider as well.
Diversification between modes of investments
(i drew this myself)
Aside from stocks or securities, there are other modes of investments to consider, which include, Bank Savings Accounts (albeit often carrying low interests), Bank Fixed Deposit Accounts, Government Bonds, Company Bonds etc. Please note that there are many others as well and I will not be going into them as I believe these are the most common ones a new/basic investor may be considering. I also would not be going into detail with regards to each specific mode of investment (not in this post), as my point here is that, there are many ways and levels in which an investor can choose to spread his/her risks.
Some important questions to ask is therefore; what am I seeking to achieve from the investment? (capital gain vs yield) How much am I willing to risk? How much do I need the money I am putting down as an investment? Have I done sufficient research to ensure that I am not diversifying for the sake of it?
Perhaps when you are able to answer all of those questions then you have an investment idea that is ideal for your own palate.
My 2cents,
A 😁
