Is Portfolio Diversification Always the Best Investment Strategy?

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Diversification is number one suggestion by professional advisors

It is natural for people to reconsider their investment strategies if they had a bad quarter of disappointing results. Something similar happened to me in 2010 as far as my portfolio is concerned. I have been investing for about 3 years now, ever since I graduated from school. I made some good moves at the right times last year when stock market around the world were just melting down (soon I am going to publish my strategies because I am so proud of what I was able to pull off). As a result I received about 70% returns on my investment in 2009 . Wish I had more cash but that is another story that I am not going to go into today. Based on that performance, I was expecting 2010 to be good too. Obviously I was not expecting similar returns again this year but I was confident on my trading skills I almost knew from day one that I would be able to get decent returns from the stock market in 2010 too.

Unexpected Stock Market Movements in 2010

2010 has not been a great year for me at least. I have not lost any money but my returns are a dismal 10%. So I took a step back and started thinking over my investment strategy. I am going to share some of my thought process today in this post.

Diversification Sounded Like the Best Solution

I have always believed in the theory of diversification. I believe you should never put all your eggs in the same basket because then you run into the risk of loosing everything because of phenomenon which are not even under your control. Therefore I kept my investment in a variety of sectors throughout 2009. So why did the strategy start failing in 2010? Well first of all, 2010 has not been good for stock market as a whole. Last week Dow Jones ended up being in positive territory after 5 weeks of continuous fall. So was the reason behind low returns just market condition or something else? Obvious answer is market conditions affected how my portfolio ended up where it is, but at the same time I think I ran into something valuable: Power of Less!

Then I realized “The Power of Less”

I read through a book “The Power of Less “ by Leo Babauta. It is an excellent book which explains some of the problems I faced towards the end of 2009 and early 2010. In 2009 as my stocks provided me more and more returns, I also started diversifying my stocks as everyone suggests. By end of 2009 I had investments in over 30 different stocks. They were spread over 6 different industrial sectors: technology, manufacturing, international, commodities, entertainment and transport. However because of the investment being spread too much, I had to spend more and more time reading through investor reports, companies’ financials, industry forecast. My focus on each of those investments started reducing. Then as you can see, I lost track of what I should have been doing during my trading time (I do not feel comfortable living my life completely on trading yet, still few years of experience needed ). Obviously I cannot spend my entire evenings and weekends researching, I like to have a life. So I got to be able to focus!

Diversification can work but at the expense of your personal life

This is where the importance of the book comes. It argues how during our everyday life in hope of making more money, living in a bigger house we end up working more and more and pretty much kill our personal life. It then describes how it is good to work more but how sometime we loose focus and start working on a lot of things that are not important. It then goes on to establish the importance of setting limits. Limits for yourself. So for example nowadays for every investment decision, I essentially ensure I am not investing in more than 3 sectors and 8-10 stocks at any given time. I also started focusing on articles and also reading good analyst comments rather than relying everything on internet. So I tried finding out my favorite analyst and started following them more. Fool.com Motley tool is among the best out there btw!

Smart Trading is no different than Haiku Poetry

The book provided some beautiful examples from Japanese poetry of haiku. In Haiku you can use only 17 syllables in three lines. The best authors of the poetry are the ones who leave out all the non important words in their message and keep the most important ones. Similarly in investments you should set your limits. Diversification is good as long as you have complete knowledge about your entire portfolio. So if you are facing similar problems as me in your portfolio, try this strategy of investing in less stocks. I am sure it would help you out both maximizing your returns as well as optimizing your personal life.