Diversification is a strategy to mitigate risk by allocating capital across different investments. Most people believe a good portfolio is diversified across different stocks and bonds. An “advanced investor” would go further to say make sure you are spread across the 11 different sectors of stocks: Information Technology (IT), Healthcare, Financials, Real Estate, Energy, Basic Materials, Communications, Industrials, Consumer Discretionary, Consumer Staples. They may also diversify across different types of bonds: Corporate Bonds, Savings Bonds, Treasury Bonds, or Municipal Bonds to name a few.
Invest in a couple individual stocks or ETFs focused in each sector and one would believe they are diversified.
I will tell you that the above definition would fail you in making you well diversified. “Investments” is the key word; in general, a lot of people believe investments are again only stocks or bonds.
Being truly diversified and a better definition for diversification would be a strategy to mitigate risk by allocating capital across different asset classes, Paper, Commodities, Real Estate, Business.
The best thing that a financial advisor will tell you to do to protect yourself from loss of capital with investing is you need to diversify. Diversification should be important once a substantial net worth is built up and furthermore, focused around cashflow (What’s more important, net worth or cashflow?).
Asset classes work in cycles, and in some capacity, asset classes work in different cycles from one another. Do not get mad at me over this oversimplification, because this is a very simplified statement. To preserve a foundational understanding of diversification, let’s just work off that simplification.
Anthony Pompliano, who is a Bitcoin enthusiast and entrepreneur, said “concentration builds wealth, diversification protects wealth.” After searching that statement and Anthony saying in a YouTube video that he heard that statement from someone else, it was legendary investor Warren Buffet saying, “Diversification may preserve wealth, but concentration builds wealth.”
Both as successful individuals did exactly that with their own lives. They concentrated their capital and investments into a specific asset class first, became experts in their fields, and continued to focus on what they knew best. After amassing a substantial amount of wealth from their early investments, they began to diversify into building other businesses, invest into other asset classes, and expand their capital by working with other experts. From a recent YouTube video on Anthony Pompliano’s old channel The Best Business Show, he says to have about 90-95% of his investments in crypto and the rest in private equity investments. Warren Buffett has majority of his investment in Berkshire Hathaway, which is his business that has many business investments within it where he has major equity positions.
Diversification is great to protect your wealth. Spreading risk across different asset classes will help reduce the chance of losing a substantial part of your portfolio. Concentration is great to build your wealth. Focusing into a specific asset class and becoming good at one thing within that asset class will increase your income and ultimately increase your net worth.
This doesn’t diminish the need to try, learn, and educate yourself on different asset classes prior. Some asset classes are more capital intensive to start then others, but getting superficial education from reading books, watching YouTube videos, or cheap or free methods to learn what interest you first is the actual first step and then concentrate to build your wealth.
Once substantial wealth is acquired (which is dependent on everyone’s goals and values), then diversification can begin. This again varies for everyone, but construction of a proper asset allocation for your portfolio is the next step.
We can discuss asset allocation in the next post to help you understand ways to think about constructing a proper percentage to different assets. For now, understanding diversification is good to protect your wealth will help better start your path onto becoming financially free.
To the New World and the New You, much success in finding your financial freedom.