Diversification of the portfolio: some thoughts

Many people tell you to diversify your portfolio. I think you should have about 10 stocks that you are confident with following my method. Think about it: each of the 10 stocks is a good business AND cheap, and you buy it with a margin of safety, so that is extra protection. If 1, 2, 3 or even 4 of these stocks suddenly misbehaves (like in my case: GILD), its OK. The changes of it misbehaving are low, as with a margin of safety of 30-70%, you already buy it at a much cheaper price than it should be.

Overdiversification is just plain stupid. Lets take the example of EFTs. Why on Earth would you buy an EFT? You buy 100s, if not 1000s of stocks with it, both good, bad and plain ugly ones. Even more insane is buying EFTs that track a certain sector, say like ‘solar energy’. “He solar energy is going to boom in the next decades, so lets invest!” A solar energy EFT comprises all kinds of solar companies, from the bad to the good to the ugly. Just look for that 1 good company, and check the stock price. No need to buy them all and dilute your returns!

What bothers me the most is gold. “Yeah, lets buy gold, because if the stock prices go down, the gold will go up, and I am covered!” My point is, why buy stocks then in the first place, as you enter a zero-sum game by buying gold.

Bonds, I have to say is something different. I have bonds. They are very different from stocks, and unrelated to stocks (OK, they are a bit but lets not get technical). With bonds, you basically by debt. No risk (unless you bu junk bonds, which is plain stupid), and a fixed return.