Post of the Day
September 8, 1998
Cisco Systems Folder
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Subject: Re: Comments on Falling and Market Overall
Convential wisdom states that a diversified portfolio decreases risk. I question this assertion. How many exceptional companies can you find. An even more powerful axiom is that diversification will limit your upside potential.
Let me preface this by saying I'm long on Cisco big time, and think they're a great company. But this comment scared me a bit. These two things are flip sides of the same coin. Diversification reduces risk. Period. Risk affects upside and downside potential, but it affects them the same. One is not more powerful than the other. They mean the same thing. You can't have upside potential without downside risk.
|"Diversifying across sectors means that a fall in any one sector of industry will not destroy you."|
A truly diversified portfolio DOES decrease risk, but not the risk you're talking about. No stock is bulletproof. The risks that diversification reduces is sector risk, regional risk, and company risk, among others.
Diversifying across sectors means that a fall in any one sector of industry will not destroy you. Let's say someone comes out with technologythat makes networks obsolete? Where will Cisco be then?
Across regions means that if California falls into the ocean, and every company with it's headquarters there falls in with it, you're not wiped out.
Across companies means that if John Chambers and the rest of Cisco management dies in a freak volcano eruption, you're not wiped out. Of if they decie netowkrs isn't where it's at anymore, and decide to produce wine.
|"I don't think I'd be comfortable betting my entire life savings (or evn a significant majority of it) on any single management team."|
Obviously these are extremes, but the idea of diversification is not unsound.
Personally, I don't think I'd be comfortable betting my entire life savings (or evn a significant majority of it) on any single management team.
Yes, diversification reduces upside potential. That's because it reduces overall volatility. In general, you can't minimize downside risk without reducing upside potential as well. that's just the way things go.
The Foolish approaches don't do better than mutuals or the S&P because they're less diversified. They do better because they're more selective about the stocks they do pick. Similarly, if you're more careful about he stocks you pick, you can be diversified and still do better. Find the Cisco in every market. If there isn't one, don't invest there. If there is, bring it into your portfolio.
Well, now that I've ranted, this probably doesn't belong here. Sorry 'bout that, gang.
Just my 3c.
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