The Wizard of Omaha has stated that “Diversification is protection against ignorance. It makes little sense if you know what you are doing.”
Most people take this as a set rule against diversification, but that’s the wrong way of looking at it. In one of his lectures, Warren Buffet stated quite clearly that if you are not an investor by trade then you should diversify.
But if you are an investor by trade, then it’s your business to understand businesses. And instead of having a small stake in many businesses, it might be better to have a larger stake in a few good companies.
Which type of investor are you?
Now you have to decide which type of investor you are. If you’re a professional investor, you might not need to shield your portfolio behind diversification — and you might focus on higher returns on concentrated investments that you understand instead of safe but moderate returns on a diluted range of businesses.
But if you’re saving up for retirement and weighing the safety of your capital against the growth potential, then diversification might just be the thing for you.
Should you diversify?
If you’re not a professional investor, diversification might be your most effective tool against the nuances and mysteries of the stock market.
It’s important to understand that there are different types of diversification. You might build a portfolio based on some longstanding Dividend Aristocrats along with some growth stocks to balance things out. You can also choose your stocks from various sectors rather than choosing different companies in one sector, as additional safety.
One such pairing would be Emera and goeasy.
Emera is a Dividend Aristocrat that’s increased its payouts for 13 consecutive years. The company is stable and works in the evergreen business of energy. Currently, the company is offering a decent yield of 4.2%. The company has done well on the growth angle as well. Its five-year compound annual growth is 13%.
Goeasy is a very different company, however. It’s in the financial sector and has its own unique business model based on low value loans. The company is a growth monster, with a CAGR of 33.6% in the past five years. The company is also increasing its dividend payouts for the past five years.
Both companies have solid fundamentals and a relatively stable balance sheet. Even if you allocate about 50% of your fully stocked TFSA to the combination of the two companies – about $17,500 each — you’ll be earning over $1000 a year in dividends, and your $35,000 investment might reach $43,000 by the next year.
Listening to the Wizard of Omaha on the matters of investing is surely a wise move. But not every bit of his advice may be right for you. Just like your portfolio and your investment goals, choose what’s best for you.
And even in diversification, don’t choose randomly or whichever stock is cheap. Study the stocks as much as you can so you don’t make any costly mistakes with your hard-earned money.
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 Adam Othman has no position in any of the stocks mentioned.