Diversification

Laurie Frederiksen on

Here's an interesting question. There's a lot of information out there that says diversification of your investments is important.

But, if you diversify into things you have no expertise in, for example companies with business models you don't understand or other assets such as commodities that bring with them a specialized learning curve, do you believe you will ultimately end up better in the long run? How can you make informed investing decisions if you haven't developed the expertise to know when to buy and sell them?

Does it make more sense to have a less diversified portfolio of investments in companies you really understand so you have a better feel for when to get in and out of them?

What do you think?

Laurie Frederiksen
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Mike Jones on

My club decided to diversify into small-cap stocks and purchased shares in a company with which one partner was very familiar. Our thinking was that a small, rapidly expanding, agile company could reward us more than a large, slowly growing, reliable company.

We found one company that was relatively small (market cap of $28 million) and saw that it was growing revenue and sales at double digit rates. Because it is small, no one cared and the stock price ranged up and down less than a dollar per share over two + years. Since it is small, analysts don't report on it and have no opinion about it. Since it is small, there was little demand for the shares and only around 2,000 shares trade per day.

We watched it for more than two years, sold it at a small profit, and went back to slower growing large- and mega-cap stocks. They will never grow at double digit rates and their price will be punished whenever an analyst guesses wrong about their earnings, but in the long haul, we can expect 5-8% growth in our investments.

Most of my partners were in the I.T. industry and over the years we purchased several solid companies that we regarded highly if they also met our SSG targets. It was a good example of Peter Lynch's "Buy what you know" philosophy and we mostly did well. Of course, not all technology stocks do well for extended periods so we had a few clunkers too.

I would suggest this article on that topic: Peter Lynch's 'Buy What You Know' Is Just The First Step



Peter Lynch's 'Buy What You Know' Is Just The First Step In Bill Gross' most recent "Investment Outlook" commentary, he begins by musing aloud whether Peter Lynch (and other legendary investors of the latter ha...

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Mike Jones

Wall$treet Wannabees

Bloomington, MN

From: Laurie Frederiksen <laurie@bivio.biz>
To: The Club Cafe <club_cafe@bivio.com>
Sent: Friday, August 29, 2014 11:45 AM
Subject: [club_cafe] Diversification

Here's an interesting question. There's a lot of information out there that says diversification of your investments is important.

But, if you diversify into things you have no expertise in, for example companies with business models you don't understand or other assets such as commodities that bring with them a specialized learning curve, do you believe you will ultimately end up better in the long run? How can you make informed investing decisions if you haven't developed the expertise to know when to buy and sell them?

Does it make more sense to have a less diversified portfolio of investments in companies you really understand so you have a better feel for when to get in and out of them?

What do you think?

Laurie Frederiksen
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John Rice on

I would say that the answer would depend on the individual or club. Take for example commodities. I knew what a commodities were but I didn't know how commodities reacted in the market. Commodities can be a hedge against inflation and I wanted some protection. I did a little research and bought a small position in my first commodity. I then had some "skin" in the game and it increased my drive to learn more about it. Commodities are affected by many different things other than the producer itself such as the CPI, GDP, China (the largest commodity consumer) / Quantitive Easing / overall market direction and the US dollar. Even though I agree with you that you shouldn't invest in something that you don't understand a small investment in something to get you into understanding it is good. As your understanding of it grows your size of the investment can grow also.

John Rice

ABODI Investment Club

On Friday, August 29, 2014 9:45 AM, Laurie Frederiksen <laurie@bivio.biz> wrote:

Here's an interesting question. There's a lot of information out there that says diversification of your investments is important.

But, if you diversify into things you have no expertise in, for example companies with business models you don't understand or other assets such as commodities that bring with them a specialized learning curve, do you believe you will ultimately end up better in the long run? How can you make informed investing decisions if you haven't developed the expertise to know when to buy and sell them?

Does it make more sense to have a less diversified portfolio of investments in companies you really understand so you have a better feel for when to get in and out of them?

What do you think?

Laurie Frederiksen
Invest with your friends!
www.bivio.com

Become our Facebook friend! www.facebook.com/bivio
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William C. Peterson on

Diversification is important only insofar as it affects the
balance between risk and reward in your portfolio. Some
investments are inherently more risky than others, and this
risk is multiplied when you don't know much about the
investment. For example, Forex investments can cost you more
than the amount you invest, which can have a devastating
effect on your financial well-being. On the other hand,
being a member of an investment club can reduce your
investment risk significantly: you can learn about investing
without risking a large amount of money all at once. At the
same time, you can rely on the knowledge and experience of
other club members to guide you.

Laurie Frederiksen on

You both make an interesting point about diversifying for the sake of learning about alternative investments. That is a good idea, but it is a little different than diversifying to help your portfolio returns. A small position woudn't likely have a big impact on them.

In a club setting, you just need to make sure that you are not investing in something that cannot be handled by your investment club accounting. Learning about Forex or commodity investing in your club would create problems.

Laurie Frederiksen
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John Rice on

You are right Laurie about investing in Forex or commodities in the club setting. The small investment that I was referring to is while you are learning about the particular investment and can be added to (or sold) as you get comfortable. We don't invest in commodities in our club but you can use the knowledge in the club. Such as knowing what can drive the price of a commodity. For example, specific things could drive the price of gold up. Mining companies have been consolidating their operations and closing down the least profitable mines due to the low price of gold and silver. When you see these indicators and gold prices start to increase so will the profits of the mining companies. Knowing what to watch for you can buy a company like Barrick GoldCorp (ABX) or Newmont Mining Corp (NEM), which are safe for clubs. Am I correct in assuming that they are safe?

John

On Friday, August 29, 2014 12:07 PM, Laurie Frederiksen <laurie@bivio.biz> wrote:

You both make an interesting point about diversifying for the sake of learning about alternative investments. That is a good idea, but it is a little different than diversifying to help your portfolio returns. A small position woudn't likely have a big impact on them.

In a club setting, you just need to make sure that you are not investing in something that cannot be handled by your investment club accounting. Learning about Forex or commodity investing in your club would create problems.

Laurie Frederiksen
Invest with your friends!
www.bivio.com

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Laurie Frederiksen on

There are many types of commodity related investments so it is always good to ask before purchasing something. Many of them, such as commodity ETF's like GLD and SLV or oil pipeline partnerships bring along tax and account issues that range from extremely complicated to impossible to handle in bivio.

ABX is a stock so it is not a problem like the things mentioned above. But it is a Canadian company and you'll need to know to do things like file the correct paperwork with them to avoid overwitholding of Canadian taxes.

NEM doesn't look like a problem to account for.

Laurie Frederiksen
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