Jargon Busting with Hawksmoor: Diversification
A discourse on diversification inevitably involves talk of eggs and baskets, yet I confess my breakables are rarely so carefully divided. Indeed, my weekly grocery shop is fearlessly thrown into one basket. There is a rash absence of diversification permeating through my entire existence.
A properly diversified life would involve at least fifteen jobs in assorted industries and one-egg egg boxes, since who would be so reckless as to place two so close together? Diversification is an alien concept to our daily lives, so why should we pay it heed in our investments?
The religion of diversification preaches that building a portfolio with diverse investments reduces risk: if one venture fails, it will be compensated by another that succeeds. Diversification mutes the impact any one holding can have on the overall portfolio, and so a diversified portfolio is unlikely to hurtle downwards (or upwards, for that matter). It is moderation by design. Thus a portfolio of ten technology stocks is less risky than just one, though more risky than a portfolio of ten companies from a range of sectors.
There are, however, dangers of over-diversifying, or ‘diworsifying’. A fund with several hundred stocks may well have ‘diworsified’ away the skill of the manager, recreated a blancmange ‘tracker’ of the entire market, yet still charges a premium fee.
Indeed, it is estimated that once a stock portfolio reaches 20-30 holdings, much of the “company-specific” risk has been mitigated. Diversification is like fine wine: a little bit can make you merry, but a lot soon becomes nonsensical.
For further information, please contact Jill Gill at Jill.Gill@hawksmoorim.co.uk
Photo credit: jriede