If you think diversification and risk control sounds boring and uninspiring, then you are right, it is! There will always be someone out there who has placed a big bet which has paid off and as a result is doing better than you. However, big bets come with a high risk price tag whereas diversification and risk control will not win you bragging rights on the golf course, or at a dinner party, but it will help better preserve your money for when you need it.
Investors who take a big-bet approach typically have a high degree of confidence in their investment(s) – after all, if you are absolutely certain about the company or industry, why bother to diversify? Research by the University of Chicago's Richard Thaler has demonstrated that overconfidence is among the most costly traits an investor can have.
Look no further than those who have lost money in New Zealand property in recent years, those who invested all their money into tech stocks during the tech boom or those who believed unrated finance companies were as safe as banks yet could provide an interest rate twice that of a term deposit.
Mark Twain seems to say it all:
"It ain't what you don't know that gets you into trouble. It's what you know for sure that just ain't so"
The sources of issues are not the things we have identified as question marks and causes for concern in a portfolio. Rather, what causes portfolios to crater are the things that we are absolutely positive about right until unanticipated occurrences catch us by surprise.
Avoid the temptation to have too much money in one investment. The boring and more conservative approach of diversification will get you there in the long term. And remember the old adage "if something sounds too good to be true, it probably is".
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