“Undiversifying”

As we explained in another article on diversification, the neutral setting for most normal investors is a diversified portfolio, at least within asset classes. That means having exposure to many different assets, almost certainly through a collective investment vehicle (a fund), making your money spread further than if you had separately invested in all those individual assets.

But, as we explained in our article on how to choose between managed accounts, funds, and individual stocks, if you would also like to select some individual assets for direct investment in your portfolio, we’re comfortable with that as long as you obey the three laws. We deem it much more likely you’ll picking individual stocks as opposed to picking individual bonds, so we’ll assume that for now.

The way we think about it – and we really do adopt this mindset when managing our own portfolios – is that selecting individual stocks is a means of undiversifying your portfolio. That is, you start diversified and then you add some concentration where you feel comfortable, following the three laws in the process. That is in contrast to starting from scratch and trying to build up to a diversified portfolio yourself, which is a very inefficient thing to do given the range of investment funds available for you to use as your diversified starting position. For example, if you have £5,000 invested in equities, you could have £4500 of that invested in a passive global equity fund and then £250 each in two of your favourite stocks. When considering the size of your individual investments, always bear in mind the transaction costs associated with the investment.

Going forward, as you put money away regularly, you’ll continue to invest further in your core passive global equity fund, especially in the absence of any strong views about a particular stock. Always keep in mind, though, that the extent of your ‘undiversification’ should be very limited, probably no more than 10-25% of your overall allocation to that asset class, as we explain in the linked articles we refer to in this post.

We refer to lots of linked posts in this post. We hope that by following the links you can answer any questions you might have, but if anything is unclear in this post, or you have any questions relating to anything investment-related, please submit comments or questions in the section below and we’ll do our best to answer them.

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