You may have heard the phrase “in order to make an omelet, you have to break some eggs.” We’re pretty sure that means that in order to achieve a beautiful thing, you have to take some risks. We’re on board with that.
However, there is another egg analogy that we swear by: “Don’t put all of your eggs in one basket.” Because we obsess as we do on smart financial planning, we believe this to mean not to sink all of your money into just one investment (concentrated investing).
Here, we’re going to break some eggs and explain the difference between concentrated and diversified investment portfolios. Read on and learn how you could place your eggs into a variety of baskets in order to ultimately create that beautiful omelet. Or at least an amazing nestegg.
Concentrated Stock Position Investments
In this world, there is one thing to be sure of: There is nothing to be sure of. Placing all of your money into one or two investments may seem like a sound plan, but you never know what the future may bring.
Say, for every Apple and IBM, there is a clunker investment that didn’t live up to its original promise. Even the most seasoned investors may not see what the future brings. Sometimes it’s great; other times, it could be a money suck. It’s a numbers game.
The more investments you have, the less concentrated risk you may face. To break it down, one sound investment can potentially make up for the poor performance of another.
Whether you are a concentrated investor or a diversified investor, risk is always going to be a thing. Let’s drill down to what each option may mean for you:
Advantages of Concentrated Stock Position Investments
One of the more notable champions of a concentrated portfolio is Warren Buffett, an investor who is very difficult to doubt.
Of investing in a concentrated portfolio, he said , “An investor should act as though he had a lifetime decision card with 20 punches on it. With every investment decision his card is punched, and he has one fewer available for the rest of his life.”
In other words, he’s saying do your homework, and when you make an investment choice, be very sure of it. And stick with it. Sounds like a solid plan, but, of course, not all of us are Warren Buffett.
Developing a diversified portfolio—as opposed to a concentrated one—takes work. If you are going to invest in a number of stocks, you’re going to need to research and understand them.
This takes time. On the other hand, focusing on just a few investments you believe in and know well could mean less fuss and less maintenance. And speaking of that, fewer investments may mean fewer maintenance and transaction costs over time. The money you save could continue to compound in your concentrated investment.
It may be prudent to hold on to a few investments for a long time and avoid all the short-term bumps and fender-benders that come along with other types of investing. The thought is to keep your eyes on the prize—all the highs and lows could eventually all come out in the wash and, in the end, you may accumulate the wealth you need.
When taking the concentrated investment route, the idea is to invest for the long term and let the funds compound. You wouldn’t need to take wide swings with investments that feel unfamiliar or uncertain. Basically, those investors just set it and forget it and have faith that the few investments they have chosen will do what they need to do over the long term.
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Disadvantages of Concentrated Stock Position Investments
Concentrated investing often takes a good deal of know-how, skill, and experience. Holding on to investments that don’t seem to move the needle can lose your money in the long run.
When you concentrate your investments, you might want to be darn sure that you are making the right decision to park your money in one spot for a long time. Staying with one investment may prevent you from taking a chance with a newer, more promising investment that could get you to your financial goals faster.
Ways to Diversify Your Investments
This is the easier part, and yet it’s not as easy as it sounds. Diversifying is merely spreading out your investment among a number of opportunities. However, you might need a strategy in mind. Here are a few ways you could do that:
Investing in more than one company. Instead of sinking all of your money into just one stock, you could spread out your money among a number of different ones.
Investing in more than one industry. For instance, media, real estate, steel, and financial services. If one industry is suffering, another industry may be booming. They might take turns winning and losing, but you’ll be there for both; and the winning might make up for the losses, but you’ll need to be in the right place at the right time.
Investing in both global and domestic stocks. This technique revolves around spreading your money around the world with the intent of protecting yourself from instability in the area of the globe that is currently experiencing challenges. Not every economy does well or poorly at the same time.
Investing in companies with different levels of market capitalization. Sounds complicated, but market capitalization is merely the market value of a company’s shares. Here’s how to do the math: Multiply the number of the company’s outstanding shares by the current market price of one share.
The answer is called the “market cap.” Example: If the company that interests you has 10 million shares selling at $50 per share, the market cap is $500 million (10 million shares x $50). This answer also shows you how big or small a company is compared to other companies. Your diversified portfolio could include small to large-cap stocks .
Investing in different asset classes. There are three main asset classes : stocks (also called equities), bonds (also called fixed-income), and money markets (also called cash equivalents). You could also consider asset classes to be real estate and now even buying and selling cryptocurrency such as Bitcoin. The idea is to change up investments with different levels of risk and returns. Different asset classes behave in different ways that are not always easy to predict. Investing in an interesting variety of asset classes can keep you diversified and can help protect you against risk.
Investing in growth stocks. This is when you invest in companies that are considered golden by many. The anticipation for a growth company’s success is high, and growth investors want to get on board without too many questions asked. You might not receive dividends right away for a growth company stock—instead, the earnings are usually reinvested back into the company in order to grow even larger. The money is usually earned through capital gains , when the stock is eventually sold.
Value investing. Here, investors look for a hidden gem: companies that may be presently undervalued but are on the verge of becoming superstars (or even just stars). If and when the company’s valuation increases, the value investors wins, earning a profit on the stock price increase. Value investors are often brave people, putting themselves in the line of danger when everybody else runs the other way.
Concentrated vs. Diversified? What to Ask Yourself Before Choosing an Investment Strategy
Before hooking up the dartboard and putting on your blindfold, it might be a good idea to have a clear idea of your endgame. Ask yourself about your investment goals and how afraid you are (or aren’t) of risk. Each stock, ultimately, is a gamble, and no one strategy is always better than another. Each investment comes with advantages and disadvantages.
Advantages of a Diversified Portfolio
Spreading your money out can help reduce your vulnerability to ups and downs. Another word for this is volatility . That’s when you can measure your portfolio risk by exact numbers, using a specific formula. From there, you could decide how comfortable you are with that risk factor.
If all of your money is concentrated into one industry, market sector, or asset class, you might suffer when that category does not do well. As a result, you could lose money and fall behind in achieving your goals.
On the other hand, diversification could open you up to more opportunities when a certain category of investment starts to improve or even blow up.
Think of those investors who believed in Apple back in the day—they may have invested in other stocks as well, but they wouldn’t have been able to miss the big gains that Apple started to earn on a consistent basis. If you’re still in your 20s, you might have the chance to find the next Apple and get an amazing head start.
Disadvantages of a Diversified Portfolio
You might hear so much about the awesome benefits of a diversified portfolio, but remember that no sure thing is a sure thing. Here are a few red flags you could look out for when it comes to diversification:
Over-diversifying. Diversifying may be good, but over-diversifying is not. If more of your stocks are doing fair-to-poor than the few that are doing well, you won’t be getting ahead. A situation like that calls for some reconfiguring.
Maintenance and transaction costs. If you invest in funds that charge fees, your diversification might nickel-and-dime you and get in the way of your good time.
Lack of knowledge. If you haven’t done your research and due diligence and if you are just going on hunches, instinct, and hearsay, you could be in for a world of trouble. Don’t diversify for the sake of diversification. Instead, you might want to take educated guesses by schooling yourself.
Whether it be concentrated or diversified investment, consider this first:
Where to put your money? Forbes has a few rules of thumb:
Take advantage of your knowledge of technology. Younger generations as a whole generally have technology in their DNA . That comes in handy as the tech sector seems to be changing on a daily basis, constantly evolving and turning the heads of investors. It’s a growth story when it comes to many tech stocks. You could do your due diligence and take a look at some up-and-coming tech companies, or you might want to invest in the technology you think will become a big part of our tomorrow.
Invest in your passions. What do you like? What arouses your interest? It could be anything from video games and phone apps to ecological-friendly causes or cool, innovative pet toys. They say, “do what you like and the money comes,” (although we cannot verify who “they” are)—the same may be said for investing. If you invest in something you love, it may be easier for you to follow and understand its growth. You might also enjoy checking in on your investment every day.
Invest in what you know. If you can’t find an investment you’re immediately passionate about, a good first step might be to find an investment that makes sense to you. Because investing can be confusing at times, it might help to be invested in something you understand. Eliminating as much befuddlement as possible could help you figure out a long-term strategy for your investments.
Stay steady. Especially if you’re a newbie, you might test the waters by wading in the shallow part of the pool first. You could try to find an investment that shows a rather steady history, so you can watch your investment grow and learn as you go. Some investments might double as roller-coaster rides, and they’re not for the faint of heart. Instead, starting out on the baby rides might help you get your bearings.
Find a good advisor. Sometimes it’s good to seek a second opinion. Before you take the plunge, you could consider talking to a financial advisor, who may be able to tell you the stuff you never would have known on your own.
Diversifying With SoFi
Portfolio diversification might give you peace of mind, but it shouldn’t stop there. Doing your research to know what you are getting into could help. The more of a mix you have, the more diversified you’ll be.
Investing with SoFi Invest is an easy and convenient way to get started. Most important, SoFi could help you map out a plan and a plant a goal post to help you work on achieving the very things you want out of life, be it retirement or emergency savings, a downpayment on a new home, or preparing for a family.
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