Diversification

[kennynah]

many great points...

i'll just add that diversification is for the purpose of risks mitigation... to properly diversify, one needs to spread $ into various asset classes...not just within equities asset class...

if one has sufficient funds for investment, asset allocation is the macro form of diversifying one's risks...

so, money could be parked in properties, stocks, FCFDs, forex, running a business outfit, antiques, etc....

within each class;

eg property, one can further diversify with international purchases...1 in sgp, 1 in cambodia, 1 in aussieland, 1 in russia, whatever.... to mitigate risk of all properties in one single country (country risks)

eg, FCFD, one need to choose a few currencies instead of just USD or Euro

eg, as for stocks...as i mentioned, the simplest is to buy the sector ETFs, financial ETF will represent a group of financial companies....even if one collapses, the ETF would not be as hard hit as that single company....similarly, there's Oil ETF or Gold ETF, etc...buying a few of them is as diversified as one can get...

make sense?

[Cheng]

Diversification is to prevent non-systematic risk like company related problems from hitting your portfolio. And therefore, the more you diversified, the chances of non-systematic failures hitting your portfolio hard will be reduced.

No matter how much research that one had done on a company, there is still a chance (no matter how small it is) that it will fail. Therefore, diversification reduces this risk.

Diversification doesn't mean equal allocation in each stock in the portfolio. One can choose to underweight or overweight individual companies in a diversified portfolio.

How I manage my portfolio? Simple. Because a well-diversified portfolio will not be prone to non-systematic risk from hitting it hard, there is no need to monitor any stock in the portfolio closely. Therefore, there is no need for me to take profit or cut loss, since my portfolio is well-diversified. By not taking any profit or cut loss actions, I minimize errors due to wrong judgement of my actions.

I let my winners run and I don't cut my losing stocks.

Hi ghchua,

Thanks for the prompt reply, hope to hear more from you in other discussions too! I have been reading your blog since 2006.

I learn from everyone and formulate those ideas that suit my goals, situtation and personality. Hope to get the best returns possible with my small account size.

Cheers!
Cheng

[ghchua]

Welcome to the forum ghchua

You must be one hell of a good investor, no need to cut loss.

Please do share how you pick your stocks.

Hi millionairemind,

It is not that I am a good stock picker. Rather, because of diversification, I do not need to care whether the stock needs to cut loss or not. Diversification takes care of my portfolio, which means one stock's allocation is not big enough to affect my portfolio, even if it chalks up massive losses.

[ghchua]

I can't agree more with this statment by W. If you buy Singtel, Starthub and M1, there is no diversification since all three comanies operate in the same industry and are exposed to the same risks. The key to diversification is finding uncorrelated assets.

I don't agree with the above statement. Even if all the 3 companies are in the same sector, diversification helps to reduce non-systematic risk like corporate fraud.

Share price movements is not the biggest risk for me. The biggest risk is companies failing and couldn't get back again. Diversification helps to reduce the risk of your portfolio being knocked out permanently from company failures.

Diversification across S-chips helps. Yes, there are some lousy ones but there are some good S-chips too. The key is to practice diversification across stocks and also time diversification by buying value stocks across different period of time.

I am sure those who bought S-chips like Changtian, Z-Obee etc at less than 10cts last year are happy now. Again, diversification allows you to consistently buy into the market without fear, since you know that your portfolio risk is lower than a focused one.

[winston]

Very good discussion here..

Diversification only mitigates Company Specific risks. It does not mitigate away Industry Risk, Country Risk or Currency Risk.

When a certain industry drops, say Coal, all the Coal stocks drops together. It does not matter whether I'm in Shenghua, Yangzhou Coal or China Coal, I'll be hit when the coal stocks drops.

In the financial tsunami last year, it does not matter which bank I own and in which country eg. DBS, HSBC, Citicorp, Barclays, Std Chartered etc, they all drop like flies at the same time.

I think I have mentioned this somewhere before. A very good friend had the bluest of the blue portfolio. He was invested in various industry leaders in different countries. Yet he was down a few hundred thousand when Equities worldwide all drop at the same time.

Therefore, I would start with Asset Allocation. Thereafter, I will manage Risk thru Position Sizing, while keeping an eye on Country Risk, Industry Risk and Currency Risk.

I think we may have discussed all these before in the Risk Management thread...

[Cheng]

Hi ghchua,

I also think that with your diversified portfolio, you had benefited over the years with dividends, and growth of the economy. As the economy grows, most stocks will rise in price. Over time, there will be some losers but it won't hurt much. Some will crawl back and some will not. I'm also not surprised that your portfolio has also seen enough of multi-baggers. Correct me if I'm wrong, you have been buying stocks since 2002.

Delistings, merger, rights issue, stock splits, bonus issues, most will have a good impact on your portfolio. Last year, you would also have benefited tremendously from the rights issues at deep discounts. Over time, dividends received are also reinvested back.

Oh I found back your post haha...

http://ghchua.blogspot.com/2007/02/ques ... tions.html

[cif5000]

I am collecting a lot of ideas here. No doubt diversification is a tool for reducing risk, how about improving returns?? Has anyone who is practicing diversification achieved better returns because of that? Appreciate your kind sharing...

(I am still writing my thesis)

[kennynah]

with my meagre $3 capital....how to diversify?

[winston]

Has anyone who is practicing diversification achieved better returns because of that?

Diversification achieved better returns when the stocks that you picked actually blows up. And when they blow up, they could blow up two to three at a time as well.

It's better to diversify but not to over-diversify ...

[Aspellian]

I don't agree with the above statement. Even if all the 3 companies are in the same sector, diversification helps to reduce non-systematic risk like corporate fraud.

Share price movements is not the biggest risk for me. The biggest risk is companies failing and couldn't get back again. Diversification helps to reduce the risk of your portfolio being knocked out permanently from company failures.

hi ghchua,

welcome to the forum!

I am just wondering - if one is overly diversified - eg. >30-50 stocks and assuming each stock is <5% of total portfolio - i agree that there will be cases of multi-baggers but there may also be unfortunate cases of complete bankruptcy of individual companies. Unless assuming one is top-notched in their stock-pickings and able to time purchases well during downcycles, if not, isnt it better to buy ETF as a form of diversification? (with remarkable reduction in brokerage fees - ie. one purchase of ETF vs 30 or more purchase of equities).