Diversification or “Diworseification”?

Diversification or “Diworseification”?

October 26, 2021
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Hello blog readers! Before we delve into our topic for today I wanted to express that I am so excited to begin contributing to the blog on a regular basis. I hope to keep the style congruent to that which Alex has already implemented. That is, these blogs will definitely be informative but will also be fun. Since I have already been introduced in last week’s blog, let’s jump right in!

                “Don’t put all your eggs in one basket”. I’m sure that you have heard this advice spoken to someone else or given to yourself. This can be in reference to a variety of different things. A parent could be encouraging their athletically gifted child to spread their talents and play multiple sports in high school rather than only focusing on one. This was not an encouragement I ever received as I was not all that physically gifted, but you get the example. Academically this saying rings true as well. If you spend too much time studying one subject your grades in the other subjects may begin slacking. And of course, the phrase could be in reference to literal eggs as from which the idiom originated, but I feel like that’s a less likely scenario these days.

                Investing is no different. Stock markets are volatile, the markets will move up and down and certain stock’s prices will move up and down more often than others. Putting “all your eggs in one basket” is a bad idea. If you put all the money you have available for investing in one stock you do expose yourself to large gains if that stock rises, but you also expose yourself to massive losses. Everything hinges on the performance of one stock, one basket if you will.

What is the antidote? Diversification. Spreading your investments over a wide variety of stocks, ETFs, and mutual funds in different sectors means that your money is in multiple baskets. One basket could have a hole in it and be losing money/eggs, but that’s why you have more than one. Each basket does something different and has a different purpose. Here comes a golf analogy, probably the first of many. You are allowed 14 clubs in your golf bag at a time. Each club serves a different purpose. The driver gets you off the tee and is usually the club you hit the furthest. The putter is for once you are on the green and ready to roll the ball into the hole. Now imagine if you only had one club in your bag, let’s say a putter. It would be a long day out on the links if that were the case, even more frustrating than usual. The putter is only meant for one purpose and attempting to use it for other purposes would end somewhat like this

It is great to have diversification but can be bad if there is too much of it. This concept is aptly coined “diworseification”. Often “diworseification” can be seen in someone’s investments when they have been placed in a variety of market indexes. They are diversified in the sense that they hold a bunch of stocks over many sectors, but many of the indexes have the same stock holdings. So the portfolio as a whole has the added risk of duplicate holdings without adding return potential. Going back to my golf analogy, this would be like having 3 of each club for a total of 42 clubs in your bag. You would have 3 drivers, 3 putters, etc.. Not only would this be highly illegal according to the USGA , but also unnecessary. You would have a ton of duplicate clubs meant to do the same thing and would not offer anything beneficial or unique. There is no need to overcomplicate things.

You need different clubs to pull off different shots and have a successful round.  But, having a bunch of the same clubs will get confusing and can do more harm than help.

                Well, that is the end of today’s blog, my first blog in fact. Those of you who are not new around here know what must come next, the song of the week! I have thought long and hard about this, after all, if we’re being honest, this is the reason you’re here. The song definitely keeps with the golf vibe of today’s blog. Enjoy!

Straight Down The Middle - Bing Crosby

 

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. All investing involves risk including loss of principal. No strategy assures success or protects against loss. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.