Diversify the golden rule

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Of all the investment rules, diversification has to be one of the most important.

Sunday, August 3rd 2003, 6:27PM

by The Landlord

It is a basic principle of investing and extremely well known - entire forests have given up their lives to prove its importance. Even so, many investor's disasters can be traced, at least partly, to a lack of diversification.

Why, when everyone knows how important diversification is, do so many otherwise sensible investors ignore this basic rule? Given the extent to which diversification has become part of investment best practice, there must be some powerful forces pushing people in the other direction - towards concentrated, higher-risk portfolios.

PROBLEM 1: GREED

That's right, greed, avarice, usury. Concentrated investment portfolios often result from plain old greed, otherwise known as the pursuit of high returns...

PROBLEM 2: NEW ISSUES

Stock Exchange boss Mark Weldon tells us that initial public offerings are the lifeblood of a stock exchange, but portfolio theory suggests that it is largely the institutions that should be buying new issues, not individuals...

PROBLEM 3: FASHION/PERFORMANCE

Fashion has a pervasive effect on financial markets, influencing large and small investors alike.
Combined with a year or so of stellar returns, the fashion/performance combination can be very hard to resist. The trick is to force yourself to acknowledge that when "everyone" is talking about the latest hot new thing, it has inevitably become overpriced.

PROBLEM 4: FEES

Love of money is supposed to be the root of all evil, so it's no surprise that, in many instances, investment portfolio construction owes more to the higher fees on some products than to any sound commercial rationale...

PROBLEM 5: ADVISER BIAS

Advisers are only human so it's inevitable that some get stuck on particular asset classes or types of investments.
Some like forests, some push high-yield stocks, a few flirt with Government bonds, many, like moths to a flame, gravitate to risky investments. (Personally, I know that I have a problem with listed property companies.)

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