Diversification versus specialization in a portfolio

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Diversification is the idea that you “don’t put all your eggs in one basket”. Instead, you spread your risk out in a basket of common stocks. That way, you don’t take the hit if one of the stocks goes down. You’re more likely to suffer no huge losses, but you also aren’t likely to hit one out of the park with this method. Diversification has a certain amount of mediocrity built in.

If you stick with the “focus” approach, you place big bets on one stock. In fact, you might even “bet it all” in the hopes of rounding the bases all on one investment. The downside, of course, is that you have no diversification. If you lose on the bet, you lose all your money. If you win, you win big. If you lose, you lose it all.

Which approach should you use? It depends on your age, your investing objectives, and your temperment. Can you actually emotionally handle losing all of your money on one trade? If you can’t, you’re probably better off going for the safety of a diversified portfolio. It’s still not a guarantee that you won’t lose money, but it’s safer than putting it all one stock.

Both methods are appealing, and either one is acceptable, depending on what you want to accomplish. You can always experiment with both approaches and see which one works out best. Sometimes trying different things is the best teacher.

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