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Diversification. What Is
It? How Much Is Enough?
 Diversification.
Many speak of diversification as if this is the goal of investing. Well it is
not.
The goal
of investing is to make money. With this in mind, I thought I would
share with you some of the things I have learned.
Modern Portfolio
Theory is something you may have heard about. One of the ideas of this
Theory is that you can get a sufficient amount of diversification from buying a
set number of stocks.
For instance if you
purchased 16 stocks, you would be able to get approximately 93% diversified.
This assumes you have the proper asset allocation. Something we discuss
all the time at Archer Investment Corporation. If you were to buy 32 stocks,
you would be 96% diversified. Amazing, all you have to do is buy 36
stocks and voila! You are diversified.
There are a few
inherent problems with this exercise. As we stated, you must have the
appropriate asset allocation for the diversification coverage to exist.
Often times, the individual investor is not savvy enough to know whether they
are properly asset allocated.
In addition, this
diversification may eliminate some of your unsystematic risk or what I refer to
as statistical risk. However, it does not reduce your systematic risk
which is the art of acquiring stocks at the right price or valuation and at the
right time or market risk.
So the key here is
not necessarily diversification. The key
is asset allocation. Why do I say this? The reason is
that most funds, just like the one we manage owns approximately 40 stocks.
Many of the 17,000 funds out there own hundreds. The problem is once you
get past 40 selections, you are more than likely increasing your chance to under
perform the index.
Modern Portfolio
Theory tells us as well as the study of some of the greatest investors of all
time like Buffett, Lynch, and others is that you should take larger stakes in
the top 10-15 stocks you think are your best selections. This is
how you will outperform the index over time.
Our goal at the Archer
Investment Corporation (which manages a
mutual fund by the same name) and Archer Financial Advisors is risk relative returns that
outperform the index over time. We address the diversification issue while
our main focus is to make money with less risk utilizing asset allocation.
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Troy Patton, CPA
Archer Investment Corporation |
Whether
you are just getting started or you have a seasoned portfolio, we
can prepare a Portfolio Investment Review (call 800-671-5872)
and let you know what your current risk levels are, expected
returns, whether you can take less risk and expect better results,
and how to better manage your risk.
(AFA
manages accounts for individuals and institutions through part of
Schwab’s institutional platform with all funds and assets held at
Schwab.) If you have any questions about this, please call Troy
Patton direct at 800-671-5872. |
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 Have
a finance question or a comment for me?
Send
it to
tony@financegeeks.com
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