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When to diversify, when to concentrate

We are frequently told not to “put all of our eggs in one basket.” At the same time, we are encouraged to “bet on ourselves.” These are clearly two contradictory approaches, so which is right?

When it comes to investing, I’ll borrow another overused quote: “There is no ‘one size fits all.’”

Perhaps the most insightful quote on the topic is delivered by the oracle himself, billionaire Warren Buffet. Buffet famously said, "We think diversification is—as practiced generally—makes very little sense for anyone that knows what they’re is a protection against ignorance."

For anyone who knows what they’re doing. There lies the key clause. As most people would graciously admit their ignorance in this realm, diversification is the tried and true path.

Investing can be a great equalizer for the ignorant. You don’t have to understand Apple’s balance sheet to share in its profits. And you can likewise understand failed companies, like Enron, Sears, K-Mart, Kodak, and Blockbuster Video, to name a few.

Even most of the people who work in the financial services industry would agree to ignorance in these areas. As a Certified Financial Planner, my skill set is in developing plans for clients, not in comparing the balance sheets between Exxon and Conoco to figure out which has more upside.

It takes a special blend of business acumen and emotional intelligence to understand markets the way Buffet does, and that’s why there just aren’t that many billionaires who amassed their fortunes as investors.

With that said, it doesn’t mean you cannot seek the benefit of large profits that come from concentrated positions in your portfolio. It’s really more a matter of your point in life rather than your knowledge. If you are in a position where you can afford to lose the money you invest without compromising your life goals, then some concentrated investments can make sense. This could be a high schooler, with some free cash and no overhead (thanks, Mom and Dad), or a retiree whose pension and social security exceed their life needs.

Your home is typically the most concentrated investment you have, but it’s an easy decision to put all of your eggs in that basket because everybody needs a roof over their head. Beyond that, business owners are very concentrated within their own business. Using your free cash flow to start a business is a great way to concentrate.

If neither of those are your flavor, then you can consider additional real estate or a single growth stock. Investors with even more appetite for risk may explore penny stocks or cryptocurrencies.

There are many methods through which you can begin to take positions of increased risk, but the biggest consideration should be the impact of a total loss on your life’s goals. If that impact seems small, then it’s probably time to begin discussing where you can concentrate some of your investable assets.

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