Mutual fund industry pioneer John Bogle recently said "Diversification is not only the first important thing investors should think about, but the second and probably the third, and probably the fourth and fifth too." Clear enough. What needs to be well understood, however, is that diversification does not prevent negative returns nor does it totally eliminate risk. Diversification does reduce or smooth out the variations in specific asset class returns.

To enjoy success as an investor, you must capture the returns from unavoidable risks (business risk, market risk) but also reduce those risks that are avoidable. Among the largest risks in this category is lack of diversification (or stated differently, holding too few positions in a portfolio). Diversification is the antidote to these risks.

Diversification provides yet another benefit that is the by-product of our media saturated age: it helps reduce emotional urges. That is, if we don't have diversification we are likely moving from one "hot" asset category to the next and making those investment decisions largely on emotion. If instead we have significant diversification then we are less likely to react since we have only a small percentage of the whole portfolio in a particular asset category.

The way we look at it, diversification goes "hand in hand" with discipline. One helps with the other. If we can reduce the short term market price shocks that inevitably occur from time to time, we stand a much higher chance of being able to stay with our plan and not panic. So much of the investing success equation depends on being able to balance short term emotions with your long term goals. They often are in opposition to each other.

We are happy to sit down with friends, family and colleagues for a "second opinion". Don't keep us a secret.

Diversification