Written by Preet Banerjee
Monday, September 23rd, 2019
"Diversification is giving up a chance for making a killing in exchange for never getting killed."
That phrase was something I heard from a colleague early on in my career back when I was a financial advisor. It was so long ago that I don't recall who the colleague was anymore, but the message is timeless.
Don't Put All Your Eggs in One Basket
If you've worked at a company (or are self-employed), you know the risk of having the majority of your revenue coming from only one client. It can be a cash cow when things are good, but if you lose that client, you're in big trouble.
That's why many businesses strive to build out a portfolio of clients or revenue sources. If, and when, one of those revenue sources dries up, the business can still continue on while looking for a replacement. With only one client, it might be game over.
For sports fans in major markets, having multiple sports franchises to cheer for is a perfect example of how diversification works. The Toronto Blue Jays and Toronto Raptors have won league championships, which brought ticker tape parades to the city that's now been waiting over half a century since their hockey team hoisted the Stanley Cup.
Diversification in Your Portfolio
One of the most prudent ways to build a portfolio is to diversify. If you took all your savings and bought a single cryptocurrency in the last few years, you might have either made out like a bandit or lost almost everything. You could have made a killing, but you could also have gotten killed. The same principle holds true for putting all your money into a single stock.
Most investors are quite happy with giving up the chance of making a killing over a short period of time in exchange for never getting killed. And they achieve this by diversifying their portfolios.
Instead of holding just one Canadian stock, you might hold hundreds of Canadian stocks. And instead of only holding Canadian stocks, you might also hold stocks from 30 different countries around the world. And instead of only holding stocks, you might also hold fixed income assets.
A well-diversified portfolio like this is easily put together with a single investment fund for people who don't want to spend the time assembling a portfolio from scratch themselves.
Take the Guesswork Out of Investing
One year, Canadian stocks might be the top performing part of your portfolio. Maybe next year it's emerging markets' stocks. And then perhaps the year after that, most stocks have a bad year and the normally pedestrian fixed income category ends up being your best performer.
Instead of trying to time the markets to guess which single asset class will be next year's top dog, with the risk of it also being the one with the most fleas, holding a well diversified portfolio with all the asset classes is the equivalent of "never getting killed."