Why not just make your best picks and focus on those picks? Why spread your assets over a number of investments? You think, “That could diminish my returns.” After all, you’re smart and know what you are doing.
Bad idea! No….really bad idea! Even the very best investors who have decades of experience, sometimes pick investments which just don’t pan out. No one knows what the future holds, sometimes the best analysis turns out to be just wrong. Maybe management has changed. A technological advancement diminishes the company’s product value. There are tons of things that could change for the worse.
Seasoned investors who have been investing for decades will tell you that they have taken their lumps. This candor happens more often nearer the “back end” of a long career. They don’t have to “sell” you are their ability to pick great investments any more. They are well established and often more self-effacing at the end of a successful career. That is why I listen very carefully to those investors who are in their 70’s, 80’s (Buffett) and 90’s (Munger).
Diversification protects you from those unexpected “bad apples”. While some investments go up, others go down. But, in general, if you are selecting quality companies that are growing long term, the aggregate portfolio is moving up over longer periods of time. The portfolio will not always climb in the short term because investments don’t always work that way. There will be periods where you just have hunker down and be patient.
With the abundance of technology today, we expect cause and effect. Like Pavlov’s dogs, we expect an immediate reward. Investing just doesn’t work that way. Take a business startup. Very few start up and just go straight up. There are fits and starts all along the way. They have to “bob and weave’ their way to success.
Many major Wall Street traders eventually “blow up”. This means they have real success for a while, but as time goes on, they become more confident and take bigger bets. Eventually, they get too overconfident and lose really big amounts of money in concentrated investments. In behavioral finance this is called the overconfidence bias. Don’t fall into that trap. Those traders find themselves out of a job, out on the street and with a greatly diminished lifestyle.
Be smart and diversify!
