Diversification Does Not Create Wealth

If your main investment objective is to create wealth and become truly financially free, diversification is definitely not the strategy you wish to employ.

Although the idea of spreading your portfolio allocations in several geographical areas, industries, and companies has been perpetuated for years, there is no documented evidence that suggests wealth is created by tip-toeing small investments here, there, and everywhere.

The hallmark of investing is to understand what you own. Can you completely understand your portfolio if it consists of several mutual funds, bonds, and equity securities that are spread amongst a number of different sectors and countries? That’s not possible. Quite frankly, if you don’t understand what you own, you are speculating—and at the end of the day, sustainable wealth is created by investing and not speculating.

A well-known fact is that more than 80 percent of professionally managed funds underperform their relevant index. Even more appalling is the fact that a large number of investors lose money when investing in mutual funds that outperform. How could this be possible? Aren’t these funds managed by experts?

When you compare portfolios of the wealthiest people with your typical mutual fund, you’ll find the wealthy have a concentrated portfolio of a few companies while mutual funds own shares of hundreds, even thousands of different companies. It goes back to the same question—can a mutual fund manager completely understand the ins and outs of so many businesses?

I would suggest you do what the wealthy do. Find no more than three sectors that you completely understand to invest in. It could be the current industry you work in or an industry that you studied for years.

When you identify the sector you’re comfortable investing in, start studying as many companies within that industry. Read their financial statements, study their annual reports, get to know their management team, and find out everything you can possibly know.

For example, I have a total of five companies in my portfolio. Four companies in the financial services industry and one real estate investment trust that is solely focused on multifamily residential real estate. I know the names of the board of directors and senior executives for these five companies, and I am up-to-date with trends in these two sectors.

Furthermore, my investments are focused in the Caribbean and the United States. This is because I fully understand the market in those locations. I don’t fully understand the economic and political climate in Europe, Asia, and South America; therefore I don’t invest in those locations. The investors that succeed are the investors that invest in what they know.

Your rate of return on investments is an important factor that will determine whether or not you create wealth. Diversification does not allow for you to maximize your returns because it is simply a stay safe strategy and not a wealth creation strategy. Concentrate your energies, your thoughts, and your capital. The wise man puts all his eggs in one basket and watches that basket.