Diversify or die
I must diversify, I must diversify, I must diversify. Get the message? I was reading some of the Banking Ombudsman's decisions recently about the ANZ debacle where conservative investors were advised to put large sums of money in risky investments. It got me thinking about how much is too much to put in one investment.
By Diana Clement
Some experts argue that diversifying widely is too much. Famed investor Warren Buffet thinks diversification is for dummies. "Diversification is a protection against ignorance. It makes very little sense for those who know what they are doing," he says. The Oracle of Omaha, Buffet, and his cohorts such as famed investor Peter Lynch practice what's called focus investing - making extremely large bets on a relatively small number of companies.
Focus investing can be a very dangerous strategy in the wrong hands. And those hands are investors who believe they are invincible - perhaps because they've had a few lucky breaks or began their investing life in a bull run.
For regular investors 10 to 20% is the maximum exposure they should have to any single investment. Less if you can't afford to lose it. That doesn't mean 10 investments in the same sector. That's gambling not investing. If one company in a sector catches a cold due to a downturn in investor confidence so might the rest of the industry sector.
Construction companies are a great example. It's the same problem that caught many people with finance companies. These "investors" thought they'd spread their money, but in fact it was all with like companies that fell over like dominoes once one, National Finance, had gone.
The only exception to this, through necessity usually, is investing in your own business. You may need to sink every last cent and more into a business. The difference is that you're 100% responsible for the governance of that company - which you're not when you invest in third party companies.
It's all very good to say diversify. But how do you do it? Are there any templates to follow? Unless you want to use a financial planner you're out on your own. Some investors use personal finance software.
I've searched the Internet and found some very useful resources, which if you're new to diversification you might want to look at - but please don't take any single one as gospel. They're a general guide and don't specifically say which investments to buy. If you're a fund investor, it's relatively easy to find funds to fit the mix. With individual equities you might want to look at the makeup of some of the leading funds to get an indication of where you should be heading.
Useful resources:
By Diana Clement
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