As an investment philosophy, portfolio diversification can have lots going for it. In particular it can help investors prone to getting caught up in the latest investment craze from doing all their dough, while for people who have many years ahead to building up a retirement nest egg it is good in part because it puts the focus on regular savings and gets the nest egg further away from temptation. But in the hands of the people who use it as a marketing tool without understanding the pitfalls inherent in mindless diversification it can become a bear trap for unwary investors. The number of retired people who have been badly burnt by having large portions of their nest eggs invested in a diversified portfolio of somewhat fringe finance companies is the most recent example of portfolio diversification being used by some individuals and investment advisors as if it was the panacea for all investors in all circumstances.
The beauty of being armed with portfolio diversification as the sharp end of a marketing campaign is that it does away with the need to be able to assess if markets are good or bad value. By contrast, the best investors in the world, including the likes of Warren Buffet, focus most on investing in things that offer great value and can be less than complementary about the merits of diversifying for the sake of diversification. The portfolio diversification marketing mantra can be most dangerous for people who find themselves with a large lump sum to invest. They might get lucky and invest the lump sum when the majority of the segments of the diversified portfolio are great value but equally they might get the short straw and invest just before a crash in a major portion of the portfolio, which is particularly relevant to the international equity market that generally makes up the largest share of diversified portfolios. We are not actively in the investment advice business and do not claim to know all the answers but hopefully this Raving will help stop some people from being drawn blindly into the potential trap of diversifying for the sake of diversification. In the context of house price prospects, an area we do specialise in giving advice to a range of firms and some individual investors via our Housing Prospect reports, we both assess whether housing is good value and have a method of assessing the near-term outlook for house prices. In my view the best active investors have both a framework for assessing value and a basis for deciding whether it is a good time to invest. And if an investor doesn't have these in his/her toolkit then maybe he/she should go down the route of diversifying for the sake of diversification albeit hopefully with a bit more insight after reading this Raving. * Rodney Dickens is the Managing Director and Chief Research Officer for Strategic Risk Analysis (SRA), which is a boutique economic, industry and property research company. Rodney produces regular free reports on topical issues and on specific property markets. Find out more about SRA here and sign up to SRA's free reports here.