Any retail investors can get in doubt when asked about which among Concentration vs Diversification would be a good portfolio strategy for his portfolio.
Even some of the most excellent guru has some different approach to this problem. Some of them advocate spreading your portfolio, i.e. to invest in various asset classes to limit the risk related to it.
Warren Buffett, the famous investors say “Diversification may preserve wealth, but concentration builds wealth.” on the other hand Jack Bogle the founder of Vanguard quotes “Don’t look for the needle in the haystack. Just buy the haystack!”
Let us analyze all the arguments and see which portfolio strategy works for you.
Let us first discuss about Concentration strategy:
What is a Concentrated Portfolio?
A concentrated portfolio can be said a portfolio that holds a small number of different securities to have a level of diversification. It can consist of 10 stocks or even less than that. A concentrated portfolio may increase your risk but with higher risks comes higher reward. One of the worlds most successful investors Mr. Warren Buffett himself advocates this idea and he says that ‘‘An investor should act as though he had a lifetime decision card with 20 punches on it.” that means with every investment decision that he makes, his card will get punched, and he will be left with fewer cards for his rest of the life.
Let us also discuss the risks related to it, the first risk that comes with concentration portfolio strategy is Portfolio concentration risk, so
What is Concentration Risk?
It is a banking term, which is used to describe the level of risk in a bank’s portfolio arising from the concentration to a single counterparty, sector or a country.
More concentration leads to less diverseness and therefore, the returns on the underlying assets are more correlated.
With Securities Concentration there is a risk of suffering losses that may occur as the investors have a large portion of their holdings in one particular investment class or market segment, in relation to their overall portfolio.
This was all about Concentration Portfolio strategy, let us now discuss about Diversification strategy
What is a Diversified Portfolio?
Diversified Portfolio means a portfolio in which the assets don’t correlate with each other. It lowers your risk, as no matter what the economy does, few of your asset classes will definitely perform. The main reason why risk will be reduced because it’s rare that the entire portfolio would be wiped out by any single black swan event.
Benefits of Diversification:
Diversification strategy reduces the overall level of volatility and risk. The simple reason is because of the simple reason that when investments in one area perform poorly for you, the other investments can offset its losses.
While Diversification is a good strategy to reduce the risk, it can also be a disadvantage for you as over-diversification can lead to low returns. To know more about Diversification you can read our blog Power of Diversification
Investors who aim to beat the market can choose Concentration vs Diversification as per their risk appetite.
While Diversification strategy is a good way to preserve wealth, Concentration is often a better way to build a fortune.