Diversification

Diversification refers to spreading risk among multiple stocks and assets. The idea is that you will limit your risk to a particular investment in the case that investment would go bad. Diversification is advocated by the majority of investment advisors and money manager on Wall Street.

But have you ever asked yourself if this a good approach? And if this is such a sound practice how come the really successful investors like, Warren Buffett and Jim Rogers don’t diversify? Or how come really wealthy entrepreneurs like Bill Gates or Henry Ford never diversified?

One of the problems with diversification is that you end up owning lot of different stocks across different industries you don’t know anything about. And it is more risky to invest in companies you don’t know anything about than investing something you have deep knowledge about.

Here are some quotes from truly successful contrarian investors…

Warren Buffett – “Wide diversification is only required when investors do not understand what they are doing.”

Jim Rogers – “Diversification is something that stock brokers came up with to protect themselves, so they wouldn't get sued for making bad investment choices for clients”

Warren Buffett – "Diversification is a protection against ignorance. It makes very little sense to those who know what they are doing."

Jim Rogers – “The way to get rich is to put your eggs in one basket, but watch that basket very carefully. And make sure you have the right basket.”

William O'Neil – "Diversification is a hedge for ignorance"

I agree with Warren Buffett and Jim Rogers. If you really take the time to understand an industry and do the due diligence about each company you invest in there is little need for diversification. I am not saying that you only should invest in a single company. But broad diversification just for the sake of diversification across all sectors of the stock market, bond market, and commodity market is counterproductive.