Best of the Week
Most Popular
1. TESLA! Cathy Wood ARK Funds Bubble BURSTS! - 12th May 21
2.Stock Market Entering Early Summer Correction Trend Forecast - 10th May 21
3.GOLD GDX, HUI Stocks - Will Paradise Turn into a Dystopia? - 11th May 21
4.Crypto Bubble Bursts! Nicehash Suspends Coinbase Withdrawals, Bitcoin, Ethereum Bear Market Begins - 16th May 21
5.Crypto Bubble BURSTS! BTC, ETH, XRP CRASH! NiceHash Seizes Funds on Account Halting ALL Withdrawals! - 19th May 21
6.Cathy Wood Ark Invest Funds Bubble BURSTS! ARKK, ARKG, Tesla Entering Severe Bear Market - 13th May 21
7.Stock Market - Should You Be In Cash Right Now? - 17th May 21
8.Gold to Benefit from Mounting US Debt Pile - 14th May 21
9.Coronavius Covid-19 in Italy in August 2019! - 13th May 21
10.How to Invest in HIGH RISK Tech Stocks for 2021 and Beyond - Part 2 of 2 - 18th May 21
Last 7 days
Transitory Inflation Debate - 15th Jun 21
USDX: The Cleanest Shirt Among the Dirty Laundry - 15th Jun 21
Inflation and Stock Market SPX Record Highs. PPI, FOMC Meeting in Focus - 15th Jun 21
Stock Market SPX 4310 Right Around the Corner! - 15th Jun 21
AI Stocks Strength vs Weakness - Why Selling Google or Facebook is a Big Mistake! - 14th Jun 21
The Bitcoin Crime Wave Hits - 14th Jun 21
Gold Time for Consolidation and Lower Volatility - 14th Jun 21
More Banks & Investors Are NOT Believing Fed Propaganda - 14th Jun 21
Market Inflation Bets – Squaring or Not - 14th Jun 21
Is Gold Really an Inflation Hedge? - 14th Jun 21
The FED Holds the Market. How Long Will It Last? - 14th Jun 21
Coinbase vs Binance for Bitcoin, Ethereum Crypto Trading & Investing During Bear Market 2021 - 11th Jun 21
Gold Price $4000 – Insurance, A Hedge, An Investment - 11th Jun 21
What Drives Gold Prices? (Don't Say "the Fed!") - 11th Jun 21
Why You Need to Buy and Hold Gold Now - 11th Jun 21
Big Pharma Is Back! Biotech Skyrockets On Biogen’s New Alzheimer Drug Approval - 11th Jun 21
Top 5 AI Tech Stocks Trend Analysis, Buying Levels, Ratings and Valuations - 10th Jun 21
Gold’s Inflation Utility - 10th Jun 21
The Fuel Of The Future That’s 9 Times More Efficient Than Lithium - 10th Jun 21
Challenges facing the law industry in 2021 - 10th Jun 21
SELL USDT Tether Before Ponzi Scheme Implodes Triggering 90% Bitcoin CRASH in Cryptos Lehman Bros - 9th Jun 21
Stock Market Sentiment Speaks: Prepare For Volatility - 9th Jun 21
Gold Mining Stocks: Which Door Will Investors Choose? - 9th Jun 21
Fed ‘Taper’ Talk Is Back: Will a Tantrum Follow? - 9th Jun 21
Scientists Discover New Renewable Fuel 3 Times More Powerful Than Gasoline - 9th Jun 21
How do I Choose an Online Trading Broker? - 9th Jun 21
Fed’s Tools are Broken - 8th Jun 21
Stock Market Approaching an Intermediate peak! - 8th Jun 21
Could This Household Chemical Become The Superfuel Of The Future? - 8th Jun 21
The Return of Inflation. Can Gold Withstand the Dark Side? - 7th Jun 21
Why "Trouble is Brewing" for the U.S. Housing Market - 7th Jun 21
Stock Market Volatility Crash Course (VIX vs VVIX) – Learn How to Profit From Volatility - 7th Jun 21
Computer Vision Is Like Investing in the Internet in the ‘90s - 7th Jun 21
MAPLINS - Sheffield Down Memory Lane, Before the Shop Closed its Doors for the Last Time - 7th Jun 21
Wire Brush vs Block Paving Driveway Weeds - How Much Work, Nest Way to Kill Weeds? - 7th Jun 21
When Markets Get Scared and Reverse - 7th Jun 21
Is A New Superfuel About To Take Over Energy Markets? - 7th Jun 21
Why Tether USDT, Stable Scam Coins Could COLLAPSE the Crypto Markets - Black Swan 2021 - 6th Jun 21
Stock Market: 4 Tips for Investing in Gold - 6th Jun 21
Apple (AAPL) Summer Correction Stock Trend Analysis - 5th Jun 21
Stock Market Sentiment Speaks: I 'Believe' We Rally Into A June Swoon - 5th Jun 21
Stock Market Russell 2000 After Reaching A Trend Channel High Flags Out - 5th Jun 21
Money Is Cheap, Own Gold - 5th Jun 21
Bitcoin and Ravencoin Cryptos CRASH Bear Market Buying Levels Price Targets - 4th Jun 21

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

A Value Investors View of Portfolio Risk vs. Diversification

Portfolio / Risk Analysis Sep 18, 2010 - 06:23 AM GMT

By: Hans_Wagner

Portfolio

Diversification is the one of the ways to reduce risk, or so we learned. While a properly diversified portfolio might reduce your risk of loss, it also lowers the chance you have to achieve market-beating returns.

If you are a value investor, you find that your approach already reduces your risk of loss without having to resort to various diversification schemes.


The Irony of Diversification

The idea behind a diversified stock portfolio is to hold enough stocks from different industries and sectors to reduce the risk any one stock or sector will decimate the value of your portfolio. Just as diversification works to reduce your risk by spreading out your portfolio, it also limits your upside potential as the math works against you. The more stocks you own the harder it is for the winners to overcome the losers. 91 percent of mutual funds underperform the market since they have the same problem, owning too many stocks for them to have a chance to beat the market.

What happens if your portfolio held four stocks and one doubled in price and the other three remained flat? You would enjoy a 25% increase in the value of your portfolio.

What if you held 10 stocks and only one doubled? Your return would be 10%. Still better than most portfolio managers. Hold 20 stocks and your return drops to 5%. The point is the more stocks you hold the greater chance you have to dilute the excellent returns of a few. Own enough stocks and you will achieve the market average before trading cost, that is.

On the other hand, holding many stocks in your portfolio reduces the potential you will suffer a loss from any one or a few stocks imploding. After all, the purpose of diversification is to lower the risk of a loss. The worse that can happen is the market plunges and your portfolio falls with it. That is where a diversified stock portfolio might not save you.

Since a diversified stock portfolio tends to match the market, you have little chance to beat the market. Then diversification reduces the chance that your portfolio will significantly underperform the market.

Reduce Risk the Value Investing Way

If you are a value investor, you search for quality companies that you can buy at a discount. When you buy a company at a discount, it lowers your risk of loss, especially if you have done your homework.

When you buy quality companies at a bargain, you reduce your risk of loss since you acquired each company at a bargain price. Value investors reduce their risk without having to own a widely diversified portfolio.

Value investors prefer to own a few quality stocks bought at bargain prices rather than owning a diversified portfolio of companies. Buying a stock well below its intrinsic value, allows you to realize a margin of safety that lowers the risk of a loss. Buying quality stocks at bargain prices lowers the risk of a loss without encountering the problems caused by a diversified portfolio.

In addition, when you understand a company deeply, you have a better understand of its strengths and weaknesses. This special insight gives value investors an advantage over those who follow the diversification strategy. Knowing a lot about 10 companies gives you an edge over an investor who holds 20 or more stocks in their portfolio.

The Bottom Line

Buying at a substantial discount and having a thorough understanding of the company you own, helps you lower the risk of a loss that is better than owning a widely diversified portfolio.

Value investors find success through their approach to finding quality companies. A widely diversified portfolio depends partly on the math of large numbers to help reduce risk. If you are willing to do the homework, your portfolio will thank you. Otherwise, buy a fund that matches the market. Just don’t complaint when the market remains at the same level for many years.

By Hans Wagner
tradingonlinemarkets.com

My Name is Hans Wagner and as a long time investor, I was fortunate to retire at 55. I believe you can employ simple investment principles to find and evaluate companies before committing one's hard earned money. Recently, after my children and their friends graduated from college, I found my self helping them to learn about the stock market and investing in stocks. As a result I created a website that provides a growing set of information on many investing topics along with sample portfolios that consistently beat the market at http://www.tradingonlinemarkets.com/

Copyright © 2010 Hans Wagner

If you wish to learn more on evaluating the market cycles, I suggest you read:

Ahead of the Curve: A Commonsense Guide to Forecasting Business and Market Cycles by Joe Ellis is an excellent book on how to predict macro moves of the market.

Unexpected Returns: Understanding Secular Stock Market Cycles by Ed Easterling.  One of the best, easy-to-read, study of stock market cycles of which I know.

The Disciplined Trader: Developing Winning Attitudes by Mark Douglas.  Controlling ones attitudes and emotions are crucial if you are to be a successful trader.


© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in