Diversification good or bad?

Discussion in 'Risk Management' started by oraclewizard77, Jan 22, 2009.

Diversification is the holy grail.

Poll closed Feb 1, 2009.
  1. Stay Diversified

    8 vote(s)
    72.7%
  2. Concentrate your portfolio in just a few stocks.

    2 vote(s)
    18.2%
  3. Stay with Cramer

    1 vote(s)
    9.1%
  4. Way too many polls here on ET

    0 vote(s)
    0.0%
  1. oraclewizard77

    oraclewizard77 Moderator

    I currently have one really good stock idea but most of my portfolio is diversified.

    I was wondering if I should sell down most of my other other stocks to concentrate on this idea if it works out could be a 300% return or play it safe and stay will a small % of my portfolio.

    Cramer keeps harping about diversification but if the market goes down, I don't see how that really helps since all stocks go down.
     
  2. MGJ

    MGJ

    The best way to make a lot of money very quickly is to hold a concentrated portfolio, and be right.
     
  3. You better be willing and able to hold them for loooooooooooooong time. Diversify your portfolio in solid companies, such as southwest and ge
     
  4. Dont forget, diversification also means in the types of investment vehicles.

    If the stop markets is doing bad overall, yes, most of the stocks u have will probably go down. However, that doesn't necessarily mean commodities, bonds, cash, etc r all doing bad.
     
  5. Good and bad.

    If you split your portfolio into many different stocks then even if some go down others will go up. That way your wins offset your losses.

    It is much better to have only 1 or 2 stocks at a given time and limit your risk on those stocks.
     
  6. How are you going to do that if a stock gaps 20% overnight?
     
  7. hmmmmm

    This guy at sixmillionstocks.com did that and made over $6 million before CROX gapped down overnight in October 2007 and he lsot about half his money. It is the way to make big money but you need luck. Be prepared to lose big money as well.
     
  8. traderhf

    traderhf

    Let us assume that you know this stock will give 300% return, whereas overall market may give between -30 to +30% return this year, and this stock will not go to -50% before going to +30%. Its obvious that you will margin yourself to the hilt and buy this stock with 100% of your capital. Since we do not have complete and accurate foresight, lets try to solve this problem in a structured and logical way.

    Answering these questions sincerely might help you decide on how much % of your portfolio you want to hold in that stock:

    A. Set a potential range that your analysis has shown you that the stock might end up in, under different market scenarios. Make a 3*2 table where 3 rows are S&P goes up 30%, S&P flat, S&P goes down 30% in one year, and 2 columns are your stock performs good, your stock perform bad. Try to put some numbers in this table, this simple exercise will force you to do some more research and analysis before buying, and potentially give you a range of what to expect at the end of year, under different scenarios.

    B. You ideally want to consider all different scenarios while making allocation % decision, it might be tough thought. Its generally a good rule of thumb to focus on your worst case scenario and then decide on % allocation.

    Some more points to note:
    1. Above exercise will help you developing your level of conviction also. Try to assign probabilities. At this point, I will push you even further, if you allow me! Please repeat this exercise with this question as your guide: what can go wrong under all scenarios? What are the assumptions I am making here etc.

    2. Please don't focus on absolute returns only, please also look at possible correlations with S&P. Assuming say S&P goes down but this stock goes up, then it will make a lot of sense to add even more of this stock to your portfolio (I am assuming here your portfolio primarily consists of S&P stocks).

    Finally, If you really have such a solid idea, I would recommend putting in at least 3-10 days of solid work behind it, before making a decision. Because if it turns out to be correct, you stand to make a lot of money! Check balance sheet, p&L account, read annual report and try to know something about the sector. If you do not have relevant financial account background and cannot read balance sheet and pnl account, don't worry too much. Thinking through different scenarios will definitely help you make a better decision. I am sorry if it sounds like too much work, but personally I will do at least this much work if the potential idea looks so good!

    -D
    P.S. Don't worry too much about modern portfolio theory and why diversification makes sense under that theory. There are lots of assumptions which go in the theory, which most folks are simply not aware of. You don't need to run a quadratic optimization to decide your allocation. Just do basic research and due diligence and you will do good. Good Luck!
     
  9. diversification = mediocrity.

    I take the broader view. We own one house, we bet it all on red. We pursue one career path, advancing in one field. So far this is two parts of our life portfolio. Real estate and income. The last part is equities of some sort, I say go for it.
     
  10. that is what options are for. a leveraged bet without risk of total ruin.
     
    #10     Jan 21, 2010