THE IMPORTANCE OF DIVERSIFICATION

I had lunch with a group of officers from a local trust department, two of whom were investment managers. The subject came up of what to do with a client who has a high concentration of a single stock in their portfolio. The discussion was enlightening.

Throughout my career I’ve noticed a common theme, which was actually stated by one of the investment managers. “You acquire wealth by concentrating on one thing, but you retain wealth by diversifying.”
I have repeatedly seen how many of my clients have built their wealth. There have been numerous ways it has been done, but there is a common thread. Whether done through real estate investing, owning and running a business, or investing in tradable stocks, they have all focused on the one thing they knew the most about. Often, this meant that they invested in their employer’s stock throughout their career, or in their own company. Sometimes it meant they bought real property, and kept buying real property. But in every case, they ignored the standard advice to diversify their holdings. They took a lot of risk, and for them it paid off.

After acquiring that wealth, often when a person stops working, it becomes more important to preserve that wealth. That is when diversification should be the focus of your efforts. Diversification really means that you are trying to lower the risk, and by risk we mean volatility. The more your investment fluctuates in value, the riskier it is, because you may need to liquidate it (cash it in) when the value is down, rather than up. By diversifying, you smooth out the peaks and valleys and will be less likely to be forced to sell when the value has plummeted.

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