Diversification Can Be Dumping The Winner To Buy The Losers
Like many of you, I've been learning more about investing as it becomes a more important part of our lives; working for a living and saving only gets you so far, and if you're not investing, you're left behind. Investing is a complicated task even for the most seasoned of investors; no one can predict markets, and this is why many of us offload our capital to money managers instead.
Since we don't have the capital to have a money manager, some of us are speculating on our own in different markets. Some it's real estate, some it's equities, some it's corporate or government bonds, some its index funds, some its crypto or derivates.
Depending on the amount of capital you have, your risk tolerance and your time preference, you'll choose one or a few of these strategies. Ideally, we want to protect the purchasing power as goal 1 and goal 2 would be to increase that relative purchasing power over time.
Now, as you can see from the investment classes I've mentioned above, there are plenty of options. Within those asset classes are individual companies, coins, stocks, tranches, funds and contracts you can purchase to speculate in these markets.
One of the strongest narratives in investing is not to keep all your eggs in one basket, to diversify, to hedge, and overall this is a good strategy. While many of us are used to the adage of stocks versus bonds as diversifying, others are saying this is an anomaly based on monetary and fiscal policy, and you should actually diversify across different asset classes.
Such as the dragon portfolio, which is a 5 way split of
- Fixed income - bonds
- Long volilitliy - index funds
- Equity - stocks
- A strong commodity trend
Image source: seekingalpha.com
Each asset class will give you some protection should the other capitulate, as money can only go into one of these classes. The goal with diversification is to have exposure to where money is reallocated.
Diversify in an asset class
This is where people tend to make mistakes; they hear about diversification and think then apply it to one asset class. So let's say you're in cryptocurrency; instead of only owning Bitcoin as your exposure, investors will buy a bunch of other coins under the guise of diversification.
When this is, in fact, a poor strategy when you opt for the market leader in an asset class, more often than not, you're getting enough exposure at a risk-adjusted rate.
For example, in the smartphone wars, would it be prudent to put all my money in Apple or buy some apple, some Nokia, some Motorolla, some blackberry?
The answer would be all-in on Apple, the same with eCommerce with Amazon, to social media with Facebook. Diversifying in a specific market only saw you sell more of your winner to buy the losers.
A false sense of diversification
Diversification within a specific asset class also tends to provide you with too many correlated bets, which in turn has you overleveraged to market trends. If Bitcoin goes down, more often than not, your other bets will break down too.
I see many friends getting into crypto and misunderstanding diversification and not looking at risk tolerance and risk-adjusted returns, never mind the tax implications involved.
I guess it's all part of our financial education, and it's also how I've learned to rebalance my investments over time. I might not shoot the lights out with my trades, but as long as I don't lose purchasing power, I count that as a win.
Since I am still young enough to acquire more resources, protecting my purchasing power over time and growing it slowly is where I like to play.
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