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How good is portfolio diversification for Investment?

Last Updated Date - Sep 01, 2023

Portfolio diversification is a very interesting topic on Investment periphery.

Let’s answer this Question by taking two true example:

  • Rakesh Jhunjhunwala, the name needs no introduction, the legendary investor from India. He started his investment carrier with Rs. 5000 when Sensex was at 150. At that point of time i.e. in 1985 when he played his luck (?) and sold 5000 shares of Tata Tea @ 143 each. He bought those shares at Rs 43 apiece. Here we see that he didn’t go for diversification. The story would have been different if he would have diversified his portfolio.
  • Another example of is of a man whose record puts him in league by himself- Peter Lynch. He is considered America’s number one money manager. Mr. Lynch was a portfolio manager of Fidelity Magellan Fund which was the best performing fund across the globe from May 1977 to May 1990. so for a long period of 23 years Mr. Lynch managed to keep his fund in profit and stayed at No 1 rank. Not to forget the recession after recession that stuck this period. Now comes the huge number! his portfolio held some 1400 stocks at one period of time. It may be the biggest ever diversification one might have heard of.

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    Portfolio Diversification vs Portfolio Consolidation

    Portfolio Diversification in investmentSo from the above two example the question still remains unanswered as in both the example there is profit at the end of the story. But there is one thing common in them. They were choosing the stock that were bustling to rise and in both the example the investor succeeded.

    There is another catch. Every one of us can’t be Rakesh Jhunjhunwala or Peter Lynch as quoted in above example. So what should we do?

    We believe that learning never comes to an end when it comes to investing. But we need to know the basic things before we go on minting money. Earlier for retail investors capital preservation was the moto rather than capital appreciation. Once we learn to save our capital by sticking to the fundamental concept of investing, then capital appreciation occurs automatically with time.

    Warren Buffet says – Diversification is a protection against ignorance, it makes almost no sense for those who know what they are doing.

    Benjamin Graham (Warren’s Guru) – views diversification as a focal point to achieve market beating portfolio returns.

    Both the teacher & pupil have contradictory view on diversification. But the teacher (Benjamin Graham) is emphasizing on capital protection while his pupil (Buffet) is on rapid capital appreciation with capital protection.

    Now let’s consider two more example. Both the case of diversification again:

    • let’s assume Mr. TYAGI bought shares of Ashok Leyland, Yes Bank, Vakrangee, Power Grid, Navin Fluoride as its portfolio.
    • let’s assume Mr MISHRA bought DLF, SBI, Optocircuit, Educomp as its portfolio.

    Both of them have tried to diversify their portfolio. If we consider their investment period to be 3 years’ tenure, then we know that Mr TYAGI is minting the money while Mr MISHRA loses even though both have diversified their portfolio.

    So what to do?

    The answer depends upon what you want with your investment.

    Remember investment is an art that you will learn only with time. Learn the basic first and then invest so as to protect your capital.

    How many stock is too many?

    There’s a long standing debate between two factions of investment advisers, with the Gerald Loeb faction declaring “Put all eggs in one basket,” and the Andrew Tobias faction retorting, “Don’t put all your eggs in one basket. It may have a hole in it.” Though neither of them are wrong when we adopt the right strategy (example Mr TYAGI) OR we can say both of them are wrong (example Mr MISHRA)

    Few things must be kept in mind while diversifying your portfolio

    • Spreading your money i.e. portfolio diversification among several categories of stock is another way to minimize downside risk
    • Keep a mix of slow growers, cyclicals, stalwarts (like ITC, reliance Industries, HDFC bank), etc.
    • Change your diversification taste as you grow older and you can’t afford to take risk.

    At last we can conclude that neither of the strategy i.e. portfolio diversification or portfolio consolidation is incorrect till we keep choosing the right stock and buying and selling it at the right time.

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