Not Diversifying can Leave You Egg-faced

(This column was first published on Value Research India.)

A friend of mine owns a farmhouse that I often use a weekend home. Yes, you can envy my awesome choice of friends. What you won’t be envying is the utter lack of things to do on a holiday in the city where I live. For most people, the choices are limited to going to a mall, watching a movie or dining out. Thankfully, I have this farmhouse to go to. It’s located in the outskirts of the city, which means we have a nice drive leading up to it as well. Out there, there are outdoor games we can play, a pool to swim in and Mother Nature in all her glory to enjoy. It’s the perfect place for a weekend with the family, one that my son relishes as much as me.

We were there last weekend as well. As is typically the case, we were a couple of families that had planned to spend the weekend together so that the children could play with each other and the parents could yawn with each other. We had carried the required groceries with us, a part of which were a couple of dozens of eggs. I had planned to show off my culinary skills by preparing egg dishes for everyone during the weekend. The menu was supposed to consist of omelettes, scrambled eggs, poached eggs and egg curries. But alas, when I took the egg packets out of the bag, I discovered that they had gone bad. The culprit was one egg that was particularly spoilt, which had probably debased the others as well. Upon seeing this, my son quipped, “Papa, don’t you know? You shouldn’t put all your eggs in one basket.”

Of course I knew that. As someone who invests in mutual funds as well as writes about them, I know that all too well. This is exactly the reason why we advocate diversification. The investment version of putting all your eggs in one basket is putting all your money in a sectoral or thematic fund. Or even in a fund that is diversified across sectors, but has a restricted mandate as far as market capitalisation is concerned. If something goes wrong within that particular sector or if that part of the markets starts underperforming, your investments would end up in deep jeopardy.

On the other hand, when you diversify, when you spread your investments across sectors, themes and market caps, you make sure that the problems faced by one part of the market don’t affect your overall portfolio’s returns. The case for diversification is very obvious – not only does it protect your investments; it also enables you to benefit from having exposure to various segments of the market. It is widely accepted that a lay investor can never accurately figure out which part of the market will do well at what time, even experts struggle with such predictions. Which is why we diversify.

Which is also why we don’t put all our eggs in one basket – theoretically as well as practically. Otherwise, you’d end up with unwanted erosion in the value of your investments. And, like I discovered, an unwarranted drive alone to the market to fetch more eggs.

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