They say that diversification is the only free lunch. Here are 10 reasons why you shouldn't diversify your portfolio:
- When you diversify you add too many stocks to your portfolio. Instead of just focusing on one stock you are devoting time to ten or more. Thus, instead of knowing a lot about one company and what factors influence their stock price you know nothing about any of them.
- Diversification is a great way to underperform. There will always be a speculative stock in your portfolio which was given to you by a tip from your brother-in-law's girlfriend's pool boy. This speculative stock will always get pummeled and drag down your portfolio.
- Diversification minimizes risk but if you are young (under 40), at a stable job (any engineering field) and making decent coin ($80-100K) you should be looking to maximize your risk which will in turn maximize your return. If you lose some of your play money you will still have your 9-to-5 job to fall back on for income. It's like hitting the reset button on the original Nintendo NES.
- Dollar cost average until $0. As long as you know the company is in a good financial position and won't go bankrupt over the long term you could easily average down on your position and hold through any downturn. The only problem that could arise is actually understanding and believing the balance sheet (see Enron). Also, stay away from Chinese burrito stocks. Averaging down at predetermined levels during a decline will allow you to keep more sideline cash handy.
- Diversification reduces volatility. But, as we already know, volatility is "here to stay". Volatility (just like greed) is good as it will give you better buying and selling opportunities. Trust me, you won't retire tomorrow by playing it safe and reducing volatility. If I wanted to reduce volatility I would put my money in a 0.05% CD. Increased volatility can maximize your returns and make you an overnight millionaire, which is really what everyone wants at the end of the day.
- You will pay cheaper commissions. Instead of being a day-trader and spending thousands of dollars in commissions a year you could spend a couple hundred or less if you have predetermined buy levels already planned out.
- If you really don't feel comfortable holding one stock you can hedge your position using options. Maybe you notice that geopolitical news or interest rates will affect your stock in the future. Go ahead and hedge your position with some long dated puts or whatever else tickles your fancy.
- Easier to trade around positions. If you have your sells already mapped out you can more easily trade around a single position instead of multiple positions because you are allocating more money to one stock and can sell on smaller moves.
- You can't diversify your way out of a financial hurricane. During a bear market, all correlations breakdown and your diversified portfolio turns to shit and no longer works. Diversification doesn't ensure gains or protection against losses. Knowing what company to buy and when to take profits ensures against losses.
- Non-diversification makes it easier to spot and take advantage of sector rotations. A perfect example can be found in the energy and biotech sectors. Biotech stocks (according to Janet) are trading at very lofty earnings and energy stocks are trading at very discounted earnings. Everyone knows the main energy players are not going bankrupt ($CVX, $COP, $RDSB, $PSX, et. al.) and if anything they will continue to get stronger into this decline as they start nabbing up smaller companies and strengthening their position in the market. You could start building a position in one of these big energy companies and your portfolio will outperform for the next 5-10 years.
Update on 9/16/15: If you need further proof read: Hedge Fund Bridgewater Defends Its 'Risk-Parity' Strategy