DIVERSIFICATION MATTERS
Diversification must be viewed in contrast to concentration. It also must be analyzed with respect to investors’ specific time horizons. Both aspects will briefly be discussed in the following sections.
Concentration versus Diversification
Most small investors aim at reducing overall portfolio risk through concentration instead of diversification. Concentration consists of investing in a few selected products that promise high returns at little risk. Investors hope for profits from price gains rather than from dividend payments.
The disadvantage of concentration is that it works only as long as the strong price trends in selected products continue. Dreams of an instant fortune turn many investors into speculators because they forget the fundamental principles of investment strategy. Concentration became another expression for more risky investment.
Concentration works only if the selection, timing, and inherent risk of a product can be analyzed. Very few investors, analysts, or rating agencies have mastered the art of timing or risk evaluation of a product; otherwise, the financial crisis would never have happened.
It is stunning that none of the fundamental analysts are able to produce absolute return results over a longer period of time. They all come up with little more than smart comments. An analyst who shows up with the best performance on the financial instruments he recommended over the past 12 months becomes the Trader of the Year. None of the ...
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