Pros/Cons of Investing in One Asset Versus Diversifying
Here at DiversyFund we are all about helping our investors grasp a better understanding of diversification in the 21st century. This is why we have explained, below, the pros and cons of investing in only one asset versus diversifying.
Understand the Importance of Diversification
Let’s start by saying that putting all of your investment eggs in one basket goes far beyond the boundaries of the Modern Portfolio Theory (MPT). One of MPT’s key insights is that while investors need to be compensated for bearing risk, not all risks are rewarded. The market does not reward risks that can be “diversified away” by holding a bundle of investments, instead of a single investment. By recognizing that not all risks are rewarded, MPT helps to establish the idea that a diversified portfolio can help investors. Additionally, it can help investors earn a higher return for the same amount of risk.
Understand the Risks
There are many reasons why you may want to invest in just a single asset. The amount of upfront capital at your disposal may be limited at the time. Even more so, you may even be convinced that you have stumbled upon the next “Big Thing”. Whatever your motive may be; understand that the market conditions that can cause one asset to do well can cause another to produce average or even poor returns. We urge you to do your research before deciding to place one large investment.
Pros & Cons of Investing in Only one Asset
With that said, let’s start off with the PROS & CONS of investing in only one asset; whether it be a single company’s stock, bond, real estate or any other kind of financial investment.
PRO: A High ROI. The potential upside to your investment can be astronomical. This is an active investor’s dream; a single “fix-and-flip” deal that they hope will fatten their pockets after a quick resale on the market for a hefty profit.
CON: The flip side to making money with a single investment is that it can suffer from a declining market value. If your investment loses value then you have no other uncorrelated assets in your portfolio that can counterbalance those losses; this is a result of limited diversification in your portfolio.
PRO: You can build long and short-term cash flows. In turn, these will contribute to your wealth with a solid investment in one asset over time. Depending on which asset class you decide to place your money into, keep in mind that each have different risk-return profiles. Additionally, they will inevitably behave differently within given time horizons.
CON: Too Risky! The rewards can be huge. However, is that amount of risk for the reward worth the loss of your initial investment?
THE BOTTOM LINE: Diversification is essential for the survival of your portfolio in the modern day financial marketplace. However, no matter how well your portfolio is diversified, all unsystematic risks can never be completely obliterated. Investors are better able to utilize diversification to their advantage. This is done by managing risk and leveraged returns to reach their financial goals.