Should I diversify? A case against diversification.

Key Takeaways

  • A lot of wealth has been created by business people incredibly concentrated in one business – no diversification.
  • However, people tend to ignore countless cases of people going bankrupt because they were too concentrated in one asset.
  • Institutional investors looking to build a solid portfolio on the side should absolutely diversify to avoid financial ruin.
  • Diversification only works if you stay disciplined.
  • We discuss many different portfolios on this site, and most are highly diversified. They achieve diversification in two ways—one through strategic allocation targeting various asset groups like stocks and bonds and two by mainly utilizing ETFs . ETFs are also diversified on their own as they invest in many assets within strategic objective. But is that good? And a broader question can be asked, should I diversify at all?

    Should you put all your eggs in one basket?

    The short answer is, of course, No. Should I diversify? Short answer is always Yes. But there is something to think about here, is there a case to be made against diversification?

    Andrew Carnegie once said: “Put all your eggs into one basket and then watch that basket.”

    Andrew Carnegie Diversification Quote

    When we think of some of the wealthiest people of our time, Bezos, Gates, or going back a few years, Sam Walton or Rockefeller, they all made their money by being incredibly good at one thing.

    Although that may be the case, these people were so concentrated in their specific industries because they didn’t have a choice. When Bill Gates was building Microsoft, he could not afford diversification of his wealth. His personal investment portfolio was probably well-diversified if he had good investment sense.

    Another critical factor to mention is that concentration also makes a lot of failures in life. If we look at Forbes’s list of the wealthiest people globally, we would imagine the list shouldn’t change often. As you can imagine, it is far from the truth. Hard times hit specific industries at different times; companies crumble with their founder’s wealth. Outside forces crash the basket with all the eggs in it, no matter how well you watch the basket.

    Should you put all your money in stocks?

    We can diversify in many ways. We can diversify between companies, industries, asset classes, and so on. The most fundamental diversification is between stocks and bonds.

    If you decide to use ETFs, they instantly provide a certain level of diversification as they invest in some basket of companies or bonds. 

    If that is the case, why not buy 100% stock ETFs? Should I diversify even more?

    For a small group of investors, a 100%-stock portfolio can be a great idea.

    To see if you are that type of investor, ask yourself how well you handle volatility. If you are a young investor, you might have never experienced true soul crashing market declines and therefore cannot answer this question truthfully. So here is when you can confidently say that you are okay with a 100%-stock portfolio.

    • You have enough cash saved up to support yourself and your family even if the market declines by more than 30% tomorrow.
    • You won’t need access to this money in the short term. You are planning to invest for the next 5-10-20 years.
    • You have lived through a market crisis.
    • You did not panic and sell everything during that market crisis.
    • When the market crashes, you see it as an opportunity to buy more stocks at a lower price.

    I hope you can see a trend here. If you panicked during the last downturn and sold everything off, what will happen to you when another crisis inevitably happens? Likely the same thing. On the other hand, if you had invested in something like the All Weather Portfolio during 2008, you would have made money. Most investors cannot truthfully answer any of the above-posted questions. So for us, it is best to have some exposure to safer assets like bond ETFs.

    I am young and can take a lot of risks. Should I diversify or only invest in stocks?

    The traditional rule of thumb is to subtract your age from 100 and invest that percentage into stocks, the rest in bonds or cash. So a 5-year-old will have 95% in stocks and the rest in cash or bonds. 95 year old should sell all their stocks and go into bonds if they haven’t already. They most likely have very little time left on this planet, so they shouldn’t be taking this much risk. I hope you see the absurdity in this argument. Age alone does not determine how much risk you can take

    A 90-year-old with plenty of savings and investments shouldn’t move money to bonds. The same goes for a 25-year-old who has a wedding coming up and shouldn’t put all of his/her savings into high growth stocks.

    No matter how young you are, you might need the money, not 40 years from now but tomorrow. Life, as they say, happens.

    So to truly understand how much risk you can take, think about your life and circumstances in it. How likely are the events that will require you to take the money out? 

    • Are you married or soon will be?
    • Are you planning on having children?
    • Are your parents getting old and will require assistance?
    • Are your parents getting old and will leave you a lot of money?
    • Are you self-employed, and how long do you think the business will live?
    • How much money can you afford to lose?

    If you realize that you are indeed okay with some risk at the end of this journey, then go for a riskier portfolio with a higher percentage of stocks. Please look at our investment guide and free portfolio ideas to see which portfolio idea might be the right one for you and continue your research from there.

    Once you figure out the target allocation, don’t deviate from it.

    It is one thing to understand your desired asset allocation. It is entirely different to maintain that allocation. You realize you are okay with more risk and go with 70% stocks, 30% bonds. And in the last three years, this happens:

    SPY 3year gains

    You see 73%+ gain.

    Stocks outperform, and you are tempted to move your allocation to 80/20, or 100/0 to capitalize even more on the stock gains. But that would be unwise. Here is what you should do instead.

    Do not buy more stocks when the market goes up and do not sell when the market goes down

    Replace all the guesswork with discipline. Rebalance occasionally back to your original allocation. Don’t do it too often, either. Every six months should do. Sell those stocks if they have appreciated out of proportion and get more bonds. Discipline is key. Discipline is key. 

    Happy Investing!


    Andy is the author behind most posts, a web site analyzing and simplifying alternative and traditional investment vehicles.

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