Concentration And Diversification

There is a big debate around concentration and diversification when it comes to investing on blogs and twitter. It is primarily because either of them to have worked very well for some people. Others seem to mix both of them and this has worked for some investors out there too.

However, if you truly think about concentration and diversification then there is really nothing to debate. If you have invested in just one name like Amazon or Costco for a good part of last two decades, you don’t really need to invest or even think about investing in any other names. The most important thing about concentration is that it is the only way to get home-runs or in investing-speak beat index funds such as SPY (S&P 500) or QQQ (NASDAQ 100).

Diversification comes into the picture because of the cyclical nature of businesses. The last cycle that began sometime after March 2009 trough is one of the longest running cycles but it may end one day too. Most companies suffered declines during Dotcom Crash and Housing Market Crash. Now, if you own a really strong franchise you can weather the storm, but it is hard to know before the end of a cycle. If concentration gets you home-runs then think of diversification as winning through singles i.e. in investing-speak increase the odds of beating index funds over long term, no matter where we are in a business cycle.

Now depending on your assessment of where we are in business cycle you can choose to either diversify or concentrate and the extent to which you will do either. That is all you can do once you have decided on what you would like to invest in. There is pretty much nothing else in your control unless you also run the business you are most concentrated in, but that is a different discussion. It is quite ridiculous that people spend lot of time debating concentration and diversification when they should be more focused on how to get the choice and the extent of diversification or concentration right in a particular part of a cycle.

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