Why I Don’t Believe in Diversification

In the investing world, diversification is the norm but that doesn’t mean it’s the best choice.

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Before you start thinking I’m a lunatic, let me explain.

Diversification is a term that investors use to describe putting money in a variety of investment vehicles and within those vehicles, a variety of categories.

If you were to invest in the stock market, diversification means you would purchase some shares in utilities companies, some in consumer staples, some in energy and some in marijuana, just to name a few.

Investors argue that diversification is beneficial as it helps to insulate the portfolio from declines in the stock market. While this is true, the problem with this theory is that declines in the stock market may be widespread (such as during a recession) so almost all stocks will be taking a loss.

The theory that I believe in is unication (yes, I made that word up). It involves finding a company with solid financials and purchasing only that one stock. It’s a strategy I’ve used in my portfolio and due to dollar-cost-averaging and a solid underlying company, an effective one.

Dollar-cost averaging

Let’s take company ABC as an example. On January 1, the company trades at $10 and you decide to purchase 300 shares for a purchase price of $3000. On February 1, the share price is now $12, but you decide to hold it because you expect the price to increase.

It is now March 1 and the share price declined to $6, but you don’t want to sell at a loss. Finally, on April 1, the stock is trading at $11 and you decide to sell for a profit of $1 per share, or $300 in total.

That’s a 10% return — not too shabby!

Now, let’s see what would happen if you implemented dollar-cost averaging, which involves purchasing the same amount of shares at regular intervals.

On January 1, the company trades at $10 and you decide to purchase 100 shares for a purchase price of $1000. On February 1, the share price is $12 and you purchase another 100 shares for a total purchase price of $2200 ($1000 from last month plus $1200 from this month).

On March 1, the share price is $6 and you purchase another 100 shares for a total purchase price of $2800 ($2200 from last month plus $600).

Finally, on April 1, the stock is trading at $11 and you decide to sell. You have a total of 300 shares in your portfolio for an average purchase price of $9.33 per share, which means your per share return is $1.67, or a 17.9% return.

Using dollar-cost averaging, you would’ve made 7.9% more than if you’d used the buy-and-hold strategy.

Solid underlying company

This strategy only works if the company has consistent growth and profitability. The reason for this is that unication is a long-term strategy, which means that to take full advantage of the strategy you must have a company that is unlikely to go belly up within the next couple of years.

One company that I recommended recently is Savaria, which specializes in the design, engineering and manufacturing of personal mobility devices. From a financial point of view, Savaria is a solid choice, with revenues increasing from $83 million in fiscal 2014 to $286 million in fiscal 2018 and net income increasing from $6 million to $18 million in the same amount of time. This is a company that would be good for unication, as it’s showing signs of growth and profitability.

Bottom line

In my opinion, diversification won’t improve your chances of beating the market, nor does it limit the losses from declines in stock prices. What diversification does is limit your ability to make money.

Using my strategy of unication through dollar-cost-averaging and finding solid companies, you will be much better off in the long run.

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This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Chen Liu has no position in any of the stocks mentioned.

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