Why diversify? Explain to me.
Discussion
I regularly see it repeated that a growth equities portfolio should contain diversification, with a careful split between small, medium and large cap companies, from developed and developing nations, in every continent and in every sector.
Now im really struggling to see why this is nessesary, or even useful.
Im 26, so ultimately the money i invest wont be needed until im at least 50, so plenty of time to ride out the ups and downs.
So why shouldnt i chuck all my money in fast growing innovative tech companies as i see them having much greater growth potential over the coming years than something established, like BP.
If we put to one side the idea that alot of tech companies are currently overvalued, what have i missed?
Thanks
Now im really struggling to see why this is nessesary, or even useful.
Im 26, so ultimately the money i invest wont be needed until im at least 50, so plenty of time to ride out the ups and downs.
So why shouldnt i chuck all my money in fast growing innovative tech companies as i see them having much greater growth potential over the coming years than something established, like BP.
If we put to one side the idea that alot of tech companies are currently overvalued, what have i missed?
Thanks
Risk.
When you are younger then having a greater appetite for risk is arguably ok from an investment point of view. But given that most people fail to beat the % return from major market indices over a period of time, people's stock picking skills are not as great as they think they are. You only have to look at the share picking thread on here for that. MTFB fell around 70% yesterday - what if you had thought that was an undervalued up and coming superstar and sunk the bulk of your funds into it.
Clearly there are pros and cons and the happy medium is somewhere between these two:
Don't put all your eggs in one basket
Put all your eggs in one basket, and watch the basket.
When you are younger then having a greater appetite for risk is arguably ok from an investment point of view. But given that most people fail to beat the % return from major market indices over a period of time, people's stock picking skills are not as great as they think they are. You only have to look at the share picking thread on here for that. MTFB fell around 70% yesterday - what if you had thought that was an undervalued up and coming superstar and sunk the bulk of your funds into it.
Clearly there are pros and cons and the happy medium is somewhere between these two:
Don't put all your eggs in one basket
Put all your eggs in one basket, and watch the basket.
See here; https://en.wikipedia.org/wiki/Dot-com_bubble
Risk is good, speculation is good, growth potential is good.
Not every company succeeds, leadership teams fail, growth stagnates, no ability to react to changing customer trends / demands / tech'.
Risk is good, speculation is good, growth potential is good.
Not every company succeeds, leadership teams fail, growth stagnates, no ability to react to changing customer trends / demands / tech'.
The same reason you wouldn't chuck all your money into a single company.
Tracking the tech index is a good idea but its incorrect to assume over the long period the tech index will out perform the wider market anyway. In fit's and starts it may, but long run there are plenty of great companies doing just as well in other markets. I. E booze, cigarettes, fizzy drinks, media etc... Would have been better investments over the last 25 years than the vast majority of tech stocks.
Tracking the tech index is a good idea but its incorrect to assume over the long period the tech index will out perform the wider market anyway. In fit's and starts it may, but long run there are plenty of great companies doing just as well in other markets. I. E booze, cigarettes, fizzy drinks, media etc... Would have been better investments over the last 25 years than the vast majority of tech stocks.
Integroo said:
Isn't it obvious - if tech as a sector crashes (or grows slowly), so does your entire portfolio.
But i cannot imagine a situation where tech crashes. Tech is almost guaranteed to be the future.Lord.Vader said:
Before the dot com bubble burst, werent the companies trading at crazy unjustifiable PE ratios?FredClogs said:
but long run there are plenty of great companies doing just as well in other markets.
Very true.Benbay001 said:
Integroo said:
Isn't it obvious - if tech as a sector crashes (or grows slowly), so does your entire portfolio.
But i cannot imagine a situation where tech crashes. Tech is almost guaranteed to be the future.Lord.Vader said:
Before the dot com bubble burst, werent the companies trading at crazy unjustifiable PE ratios?FredClogs said:
but long run there are plenty of great companies doing just as well in other markets.
Very true.Benbay001 said:
Im 26, so ultimately the money i invest wontIf we put to one side the idea that alot of tech companies are currently overvalued, what have i missed?
There are two separate issues here, one is diversification and the other is risk.To give an oversimplified example, diversification is buying Amazon, Google, Facebook, Twitter, Netflix and Apple rather than just Apple, whereas high risk is buying a tech stock versus a utility stock or even corporate or sovereign bonds.
I think you are correct to say that at your age (same as mine for what it’s worth) we should go high risk as we can ignore the money for some time and ride out several cycles. That’s a function of our personal circumstances and risk tolerance, it’s not true for all investors.
However, for a certain ‘risk level’ you can almost always improve your returns by diversifying within that risk level. As other posters have said, there are always uncorrelated / idiosyncratic risks for a particular stock or geographic sector, beyond the general trend you are trying to benefit from.
Put another way, i guess i could ask:
Ive heard it suggested that i should put my money into a world index tracker as you will never beat the market.
I accept the arguement that its hard to pick companies and sectors that are going to grow above average.
But it must be easier to pick companies and sectors that will grow far below average, and simply not invest in them?
Ive heard it suggested that i should put my money into a world index tracker as you will never beat the market.
I accept the arguement that its hard to pick companies and sectors that are going to grow above average.
But it must be easier to pick companies and sectors that will grow far below average, and simply not invest in them?
Benbay001 said:
Put another way, i guess i could ask:
Ive heard it suggested that i should put my money into a world index tracker as you will never beat the market.
I accept the arguement that its hard to pick companies and sectors that are going to grow above average.
But it must be easier to pick companies and sectors that will grow far below average, and simply not invest in them?
If it was that easy, managed funds would always beat index trackers. They don't. I would suggest you are unlikely to be better at picking stocks and sectors than seasoned investment professionals. Ive heard it suggested that i should put my money into a world index tracker as you will never beat the market.
I accept the arguement that its hard to pick companies and sectors that are going to grow above average.
But it must be easier to pick companies and sectors that will grow far below average, and simply not invest in them?
NickCQ said:
There are two separate issues here, one is diversification and the other is risk.
To give an oversimplified example, diversification is buying Amazon, Google, Facebook, Twitter, Netflix and Apple rather than just Apple, whereas high risk is buying a tech stock versus a utility stock or even corporate or sovereign bonds.
I think you are correct to say that at your age (same as mine for what it’s worth) we should go high risk as we can ignore the money for some time and ride out several cycles. That’s a function of our personal circumstances and risk tolerance, it’s not true for all investors.
However, for a certain ‘risk level’ you can almost always improve your returns by diversifying within that risk level. As other posters have said, there are always uncorrelated / idiosyncratic risks for a particular stock or geographic sector, beyond the general trend you are trying to benefit from.
A point well made, thanks.To give an oversimplified example, diversification is buying Amazon, Google, Facebook, Twitter, Netflix and Apple rather than just Apple, whereas high risk is buying a tech stock versus a utility stock or even corporate or sovereign bonds.
I think you are correct to say that at your age (same as mine for what it’s worth) we should go high risk as we can ignore the money for some time and ride out several cycles. That’s a function of our personal circumstances and risk tolerance, it’s not true for all investors.
However, for a certain ‘risk level’ you can almost always improve your returns by diversifying within that risk level. As other posters have said, there are always uncorrelated / idiosyncratic risks for a particular stock or geographic sector, beyond the general trend you are trying to benefit from.
Benbay001 said:
Put another way, i guess i could ask:
Ive heard it suggested that i should put my money into a world index tracker as you will never beat the market.
I accept the arguement that its hard to pick companies and sectors that are going to grow above average.
But it must be easier to pick companies and sectors that will grow far below average, and simply not invest in them?
Why do you think that you can pick the companies that will ‘grow far below average’ but no-one else can?Ive heard it suggested that i should put my money into a world index tracker as you will never beat the market.
I accept the arguement that its hard to pick companies and sectors that are going to grow above average.
But it must be easier to pick companies and sectors that will grow far below average, and simply not invest in them?
Benbay001 said:
Before the dot com bubble burst, werent the companies trading at crazy unjustifiable PE ratios?
Just looked this up, here are some of the higher ones. Pretty toppy valuation levels unless you see massive revenue and profitability growth in the future (and btw some of these are vs 2020 expected earnings anyway)Amazon trades at 47x P/E
Netflix 131x
Twitter 70x
PayPal 33x
There may be huge growth in tech companies but so much of it is already priced into the valuation - the early stage investors have already reaped the benefits.
Benbay001 said:
But it must be easier to pick companies and sectors that will grow far below average, and simply not invest in them?
There is a second layer to this. Obviously dying companies and orphaned sectors (i.e Kodak, Yellow Pages) are obviously dying to everyone, so their stocks trade at very low P/Es as traders know the earnings are going to fall off a cliff.The trick is to find those companies and sectors that are dying but that the market hasn’t figured out are dying. Having the knack of doing that is hugely valuable and would make you millions (billions?) if you could do it reliably.
Benbay001 said:
If i said tech will grow faster than conventional retail, would you argue against me?
Over what timescale?If I said tech companies were much riskier than conventional retail, would you argue against me?
To what extent is that future growth already in the price?
As above, unless you believe you have some amazing ability to understand companies than the professionals who invest in them for a living, you have yo expect that their current share price reflects future growth potential and downside risks.
Benbay001 said:
Integroo said:
Isn't it obvious - if tech as a sector crashes (or grows slowly), so does your entire portfolio.
But i cannot imagine a situation where tech crashes. Tech is almost guaranteed to be the future.Lord.Vader said:
Before the dot com bubble burst, werent the companies trading at crazy unjustifiable PE ratios?FredClogs said:
but long run there are plenty of great companies doing just as well in other markets.
Very true.How do you know which technology will be the future and not become a dead end of commercial development (i.e. not profitable) or the "loser" in a battle to commercialise a new technology (Betamax Vs VCR, HDVD Vs Blu-ray) etc, to pin your hopes on all technology succeeding is frankly idiotic.
Benbay001 said:
If I said tech companies were much riskier than conventional retail, would you argue against me?
Depends, ASOS has been a massive success, so was Boo.com 19 years ago (being valued at over $1b+, until it spectacularly crashed and folded).Unless you have a crystal ball, or are the second WarrenB, which I suspect you are not as you wouldn't be posting on PH about diversification, then all I can say is good luck and perhaps try a few dummy portfolios before committing to the real thing.
My pension is plait across 4 or 5 funds, emerging markets, high growth potential (tech), ethical investments and two others I can't remember.
Edited by Lord.Vader on Friday 15th February 11:02
Benbay001 said:
Integroo said:
Isn't it obvious - if tech as a sector crashes (or grows slowly), so does your entire portfolio.
But i cannot imagine a situation where tech crashes. Tech is almost guaranteed to be the future.3 words: Dot Com Boom
Some of my friends used to work at Inktomi in the late 90s, and were virtual millionaires on paper on account of stock options and "irrational exuburance" of the sector. I remember sitting in Belgo's with my friends and their Inktomi colleagues in March 2001 as we all drank 109 Snapp shots as their shares hit $240. One of my friends still has his Inktomi options framed on his wall because that was all that they were worth by the time that my friends could exercise their options.
Inktomi at the time were the absolute epitome of the dot com boom in terms of exponential share growth $25bn valuation March 2000. Roll on 2003, acquired by Yahoo! for $241m.
The risk of all stock picking is survivorship bias and hindsight bias. Which would you have bought in the mid to late 90s: Apple or Microsoft Easy with the benefit of hindsight, but not such an obvious choice 20 years ago. Still cannot believe that Jerry Yang turned down MSFT's offer to buy-out Yahoo! in late 00s (much to the chagrin of Yahoo! shareholders, whilst MSFT shareholders were probably suffereing cold sweats).
Here's Yahoo! stock chart since '96 IPO. Yikes!
The reason for the history lesson is that when the Motley Fool forums were still around (sadly deleted), everyone and their dog were piling into Tech and making oodles of money (bull market). The "irrational exuburance" was easy to see with people leveraged out, making money, taking out interest only mortgages and investing in the tech sector (a former work colleague). Then the crash occurred, and those people who didn't take profits from the table, lost their shirts. Back to my former work colleague who to paraphrase said, "I was making hundreds a day, then I started losing thousands a day".
My argument isn't against tech companies / tech sector. It's more that your investment strategy is resting on some very, very shaky foundations, and irresprective of your relative young age, your lack of imagination could potentially cripple you financially for a very, very long time.
Before investing any money, tech, individual stocks, a passive global index tracker, et al, do some reading to develop an investment foundation (and keeping learning) before investing any money - especially if picking individual shares.
If you still wish to invest in individual tech companies / tech sector, go for it. But have an investment strategy in mind, and understand the risks and how you can mitigate the risks.
Edited by putonghua73 on Friday 15th February 11:28
If you believe in something by all means invest in it. Just make sure your belief is well founded....
The majority of successful investors simply believe in "capitalism" and recognise the inevitable consequence that businesses will have their ups and downs. So investors spread their risk to reduce downside exposure. If they think a particular type of business is on the up they will generally back the sector rather than punting everything on one company.
Buying a global equity index is the most extreme example of a belief in capitalism because, lets face it, it's the equivalent of going to the races and betting on all the horses at once so that you guarantee a win! The only difference is that in capitalist investment "winning" doesn't depend upon somebody else "losing". So everyone CAN win at the same time albeit only at an average pace.
A stock market trader is different from an investor. A trader tries to see opportunities from day to day and hour to hour, so does need losers in order to pay for his wins. This is why the vast majority of private traders lose money - they're simply not as good at it as the professionals who they are up against. Same applies whatever is being traded - cars, boats, houses, investments.
As regards tech sector I suggest you take a look at this Wikipedia page about the dot-com bubble,
https://en.wikipedia.org/wiki/Dot-com_bubble
The majority of successful investors simply believe in "capitalism" and recognise the inevitable consequence that businesses will have their ups and downs. So investors spread their risk to reduce downside exposure. If they think a particular type of business is on the up they will generally back the sector rather than punting everything on one company.
Buying a global equity index is the most extreme example of a belief in capitalism because, lets face it, it's the equivalent of going to the races and betting on all the horses at once so that you guarantee a win! The only difference is that in capitalist investment "winning" doesn't depend upon somebody else "losing". So everyone CAN win at the same time albeit only at an average pace.
A stock market trader is different from an investor. A trader tries to see opportunities from day to day and hour to hour, so does need losers in order to pay for his wins. This is why the vast majority of private traders lose money - they're simply not as good at it as the professionals who they are up against. Same applies whatever is being traded - cars, boats, houses, investments.
As regards tech sector I suggest you take a look at this Wikipedia page about the dot-com bubble,
https://en.wikipedia.org/wiki/Dot-com_bubble
Benbay001 said:
Put another way, i guess i could ask:
Ive heard it suggested that i should put my money into a world index tracker as you will never beat the market.
?
You'll never beat the market without taking on extra risk - that's a very important qualifier.Ive heard it suggested that i should put my money into a world index tracker as you will never beat the market.
?
Note also that "this time is different" has been heard many times - legislation that splits google up, actually controls facebooks data handling practices etc, could significantly change those companies growth expectations.
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