Diversification is one of the greatest myth in stock investing. The old saying of “Don’t put all your eggs in one basket” should be “Put your money in a few baskets and then watch the baskets,” when it comes to stock investing.
Financial planners will always advocate diversification to reduce and spread out your risks over different stocks However, if you do not concentrate your firepower (your money) on just a few stocks, you won’t make much money even if you make some correct stock picks. Chances are that in your portfolio of more then 10 stocks some will be winners, some will be losers and the gains get cancelled off by the losses and you end up no better off then when you started off.
Stocks picking takes time and effort in terms of research and that is why we should concentrate our time and effort on only a few stock picks. Warren Buffett says that “Wide Diversification is needed only when investors don’t know what they are doing”. He practises what he preaches because over the last 25 years, 73% of his portfolio is concentrated on only 5 stocks.
I sometimes speak to my colleagues at work about the stocks they invest in and many of them have more then 20 different stocks. The reason is simply that they do not know which one of these stocks will become the real winner and also because they do not dare to put too much money on one single stock.
In order to win, they must have more winners then losers out of the 20 companies that they have and that seems statistically less achievable then trying to get 3 out of 5 companies (all of which you have studied and analyzed in detail before putting in money) right.
To summarize, in order to have the courage and confidence to put in a bulk of your net worth into a few stocks, you have to understand what you are doing and how the company operates, right from how the first dollar flows in til it flows out and how cash is generated.
That takes an understanding of financial statements and can be a nightmare for the layman just starting to learn how to invest.
To learn how to interpret financial statements written in a simple and concise manner made for the beginner and layman visit http://www.stockinvestingcentral.com
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