“Diversification is the only free lunch in investing.” (Harry Markowitz)
In mid-1999 you could have bought shares in Amazon for $80 each. If you had been astute enough to put $50,000 into the company back then, those shares would be worth $17.4 million today.
In hindsight, that’s about as good an investment as you could have made. And if you had made it, you would probably be wondering why people fuss so much about diversification.
If you are able to identify such a big winner, why dilute your gains by putting any of your money anywhere else?
The answer to that lies in the fact that if you had bought shares in Ford Motor Company at exactly the same time, you could have got them for about $35 per share. If you sold them today, you would get less than half of that.
And the truth is that most people would have been far more likely to invest in Ford 23 years ago than they would have been to buy Amazon. Ford was one of the largest companies in the world and enjoying positive growth. Its shares had gone up more than 500% in the 1990s.
By contrast, Amazon was an experimental online bookstore, that would have been little more than a speculative bet.
Risk and reward
This shows that there are two things that you can be absolutely sure of in investing. The first is that the future is always uncertain. You can’t anticipate what will work and what won’t – over either the short or the long term.
The second, is that nothing goes up in a straight line. Ford’s shares have never regained the levels they reached at the end of the last century.
That is why diversification matters. It allows you to reduce the risk of picking a dud like Ford, while still having exposure to a winner like Amazon.
If you had put $25,000 into each of these companies in 1999, you would have $9 million today. That may not be quite as juicy as the $17.4 million you would have if you had only gone into Amazon. But it’s an awful lot better than the $25,000 you would now have if you had only backed Ford.
To discuss how to get the most out of diversification in your portfolio, speak to a professional.
Disclaimer: The information provided herein should not be used or relied on as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your professional adviser for specific and detailed advice.
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