Portfolio Diversification vs Concentration
Part 1: Introduction
The debate on diversification and concentration when it comes to investing has been around for a long time. Let’s define them so that we streamline conversation.
Diversification: this is the process of investing in different investment instruments with the goal of reducing or controlling the risks that can occur in each investment type
Concentration: this is the process of investing significantly in specific instruments and investing minimally in other investments instruments with the goal of extracting maximum returns.
Now that we have that out of the way, let’s jump to what we have been taught by society and our parents. The phrase most use to settle this debate is never put your eggs in one basket? What this means is the preference for the majority is to diversify their investments. This approach is fear driven cause it seeks to focus on the fear of things go wrong that it doesn’t consider one key scenario. What happens when you have 1000 eggs and 6 baskets what do you do then?
Today we explore what I consider a critical misconception that leads many defaulting to over diversification at the expense of wealth creation. Let’s look at the top 4 richest people in the world as per the Forbes List in Mar 2021
- Jeff Bezos $180.06B
- Elon Musk $162.4B
- Bernard Arnault & Family $160.1B
- Bill Gates $126B
Conventional wisdom would assume they are very diversified in terms of their sources of wealth. You would be wrong, in my view their wealth is heavily concentrated.
Think about this, if Amazon went bankrupt and its share price went bust. How fast would Bezos wealth disappear? Musk is a perfect example of how his wealth is heavily concentrated in Tesla. Before the pandemic, he was not even in the top 100 of billionaires in the world. Tesla stock soared more than ~800% over the last 12 months pushing him to the number 1 spot for a couple of weeks. Would Gates be in this position if Microsoft went bust? Something to note is that these 4 would live a comfortable life even if their primary money maker went bust.
A well diversified investment portfolio gives you a peace of mind but takes longer to generate wealth.
Let’s discuss this closer home, there are a lot of investment opportunities in Kenya. The challenge we faces most of the time is the fear that you don’t know what to focus on so what most people end up is participating in everything at the same time. Are they wrong? No it is a viable investment approach but I want to highlight the trap so that as you think about your investment portfolio you can interrogate it with that in mind.
We highlight this trap by providing a scenario. Let’s say my good friend Steve is 28, has a decent job making a net of 100K/month. He has some side hustles that on average net him an extra 15K/month. He wants to commit about 45K/month for investments. The options available to him are Stock Market, Sacco Contribution, Sacco Share Capital, Land, Money Market, Treasury Bonds, Insurance policies, and Forex. To put it in our earlier analogy he has 45,000 eggs and 8 baskets.
Ponder on this scenario. How would you advise Steve to allocate his money across these options? In the next article we will jump into the numbers in details and conclude on this conversation.
Happy Investing!
