Few days ago, we explained the need for diversification: read the post here.
Now add to that three important points:
- The fall in the value of a concentrated portfolio as compared to a diversified one, and
- The investor behaviour of chasing the recent past performance
- At any point in time, at least one part of a diversified portfolio would outperform the diversified portfolio itself
These three statements mean a huge risk for most investors. Let us elaborate. First of all, at any point of time, the diversified portfolio would underperform at least one part of its own. In a bull market, especially, one sector would be leading the rally. This sector hogs the limelight. Since the performance is great, many investors invest in it only after seeing great past performance, which means most of the gains have been made and the prices have reached high levels. Buying costly is always a riskier proposition for investors as money-making opportunities are less of one buys costly. The faster rise is often followed by a steep fall. The leader in the rally is generally the leader in the fall, too.
since the investor missed out on the rally and entered at higher levels, there is disappointment for her.
Read more about some more examples in the book “Riding The Roller Coaster – Lessons from financial market cycles we repeatedly forget:
#RidingTheRollerCoaster – 120