Divide your portion to seven, or even to eight, for you do not know what misfortune may occur on the earth. Ecclesiastes 11:2
There is a proverbial saying that we often hear, “Don’t put all your eggs in one basket.” But what exactly does this mean? An investment portfolio can be thought of as a large 12-inch pizza that is divided into pieces of varying sizes, representing a variety of asset classes and/or types of investments to accomplish an appropriate risk-return portfolio allocation.
Many different types of securities can be used to build a diversified portfolio, but stocks, bonds, and cash are generally considered a portfolio’s core building blocks. Other potential asset classes include, but aren’t limited to, real estate, gold, and currency.
Warren Buffett, a well-known philanthropist, shared a different school of thought on portfolios. He suggests, “Put all your eggs in one basket, and then watch that basket very carefully.” He contends, “Diversification is protection against ignorance.” In his view, studying one or two industries in great depth, learning their ins and outs, and using that knowledge to profit from those industries is more lucrative than spreading a portfolio across a broad array of sectors so that gains from certain sectors offset losses from others.
There are merits to both schools of thought for consideration. However, the average individual does not have the time and resources to simply sit around and watch the performance of a single portfolio. Hence, in most cases, the smaller investor is left to diversify under the guidance of a portfolio manager.
A diversified portfolio across asset classes would most likely include bonds, stocks, real estate, cash, and perhaps some funds. This would be very good in theory, but it is important to note that this doesn’t guarantee any protection for your portfolio. For example, if you are invested in oil bonds, oil stocks, and oil mutual funds, there is a lot of exposure there! This would have been evident in early 2020. Due to the pandemic and worldwide shutdown, there was less demand for oil. US crude oil dropped about 21 percent and moved below US$20 a barrel for the first time since February 2002. Your oil portfolio would have taken a significant hit, whether it was held in bonds, stocks, or mutual funds.
Real diversification should ensure that the exposure is allocated across different sectors. The main sectors would include financials (banks, insurance companies, investment houses, etc.), consumer food, energy (oil, solar companies, etc.), health care, technology companies, real estate, and the list goes on.
Diversification is possible even when you are a small investor. While it is sometimes advisable to take some time to save before starting your investment portfolio, there are still investment options that are possible through investment funds, whether investing in them directly or through the stock market.
Knowledge is always key. Ensure you speak with a licensed financial advisor when crafting your portfolio. When building your portfolio, try to ensure you are not too heavily weighted in any one sector.