Diversify, diversify...

In a recent article, I looked at the importance of asset allocation here. I have around 60% in equities and 40% in fixed interest securities such as PIBS, corporate bonds etc.

The equities are divided equally between individual higher yielding shares and investment trusts. The shares I hold are a mixture of large, medium and small cap - the largest is probably GlaxoSmithKline (GSK) with a market cap of around £70bn and the smallest is AIM listed Abbey Protection with a market cap of around £110m. The shares are selected from over 15 different sectors of the market such as media, mining, supermarket, utilities, general industrial etc.

I hold several investment trusts - some from the UK growth & income sector, some from the global growth & income sector like Murray International (MYI article) as well as a couple of trusts focussed on Asia and the Far East, I also have a couple from the global growth sector like Law Debenture (LWDB article) and for exposure to smaller companies I chose Aberforth.

The point is, its not generally a good idea to put all your eggs in one basket. Pooled investment vehicles like investment trusts, exchange traded funds and OEICS, will typically hold one hundred or more individual shares and these are a simple way to diversify your portfolio. Indeed with the broadly diversified Vanguard LifeStrategy fund you have the option of a one-stop investment vehicle providing all the diversity and balance that may be required.

Personally, I would never place all my investments with one fund or even several funds with just one provider. I like to spread the risk - some shares, some professionally managed investment trusts. I like some large, higher dividend paying shares and some smaller, faster growing companies. I like exposure to different sectors of the economy and to the faster growing emerging markets.

However, some would argue it is possible to be over-diversified. According to modern portfolio theory, holding around 15 to 20 shares is around the optimum for adequate diversity and adding further shares has very little effect in reducing risk. Legendary investor Warren Buffett suggests that if you diversify too much you might not lose much but equally, you won’t gain much either. His approach is to concentrate on companies he knows inside out and select a few well researched options out of which there is the expectation of some big ‘winners’.

Buffett is exceptionally experienced, skilled and disciplined in his approach to investing - many try to emulate his success but no one has come close. A return of just under 20% cagr over the past half century is a phenomenal achievement.

For the average small investor, I would think the better returns are more likely from a well diversified and balanced portfolio. Whether to include individual shares or not is a matter of individual choice - personally, I like to hold a few shares - if for no other reason than I like to play the fund manager and see if the returns from my shares portfolio can outperform the professionals running my investment trusts. I haven’t managed it so far, but maybe this year…

Keep it simple.