I do note with amusement that a former Member of Parilament’s “real estate bubble” website is advocating some strangely risky financial strategies. Apparently he has forgotten that ETFs derive their value from their underlying holdings, which contain precisely the amount of risk that he declares that people with only a million dollars and above should be engaging in. Here’s my phrase of the day: Diversification is for investors that don’t know where to find value. Diversification also does not mitigate against systemic risk, as most investors in the second half of 2008 discovered.
If your portfolio size is a modest fraction of annual after-tax income, putting all your eggs in a single basket (i.e. putting it all on a very well-researched company) is an acceptable strategy if one believes in maximizing both their risk and reward. As the portfolio size appreciates above annual income, maximum position sizes need to be trimmed down to avoid what I call “blowup” risk, but financial academics call unsystematic risk. With commissions as low as they are, people can invest reasonably with as little as $5k – with $10 commissions, you can diversify into five positions with a 1% expense ratio, or better yet, choose two and keep your expense at that of a typical index fund.
Especially for young people, it is vitally important to learn how to lose money in the public marketplace before making money – making mistakes that cost you 20% of your portfolio means a lot less when you have $5k in the account than $500k. You learn exactly the same lessons, but with a lot less money.
The worst thing that can happen to a beginning investor is that their first three trades are wildly successful.