Get all cash out of the bank

[TheHeathens]

Paragraph 1) You stated in an earlier post that DIVERSIFICATION alone is not a guarantee to performance.

Firstly, I never said it guaranteed growth in any post - I said it was an effective hedge against an economic downturn. Even with your simplistic example of 4 companies, there is a chance that you would lose less money (being an effective hedge doesn't necessarily mean you make money) than if you'd ploughed all of your money into one.

Then you went on to the 'but' 'if you've asked all the right questions.' So I'm not spinning anything. You've gone from deterministic certainty about diversification to putting conditions on it, like 'asking all the right questions.'

Let's put this to bed - you're intentionally missing the point now.

Diversification is King.

You need to diversify across a number of investments.

I've mentioned twice that Diversification is Key and you've avoided it twice - very few of our clients have lost money in the last year even with the FTSE down by about 20% because we've diversified their portfolios.

I'm not implying that diversification is good - it is good (and the FSA agrees - they could uphold a complaint for misselling against advisers if there was no diversification). The whole point of diversification is to lessen the impact on your portfolio if things go belly up - a case of not putting all of your eggs in one basket.

Diversification alone is not a guarantee for performance, but if you've asked all the right questions then it should usually provide a better hedge against an economic downturn than investing in individual stocks.

Ok, so where did I say at any point it would guarantee performance.

The problem with your argument is the asking of all the right questions. You cannot ask questions when there are no answers. One example will suffice: A few years ago pubs were doing very well here. So if you decided to buy a busy pub, then you could expect to do well. Then the fascists in government sprang the smoking ban on them. Now pubs all over the country are going out of business. Not just because of the smoking ban I know, but a big part of it.

Firstly, that's an very poor example - you could have foreseen the fact that a smoking ban was going to come in, because it had done in Ireland and a few US States to name but two beforehand. You should have asked that question.

Secondly, where's the diversification in just buying just one pub? You've perfectly proved my point with that example! If you ploughed all your money into one investment (like gold, or the pub in this example) you shouldn't be too surprised if it falls in value.

Diversification would be (for example purposes) buying a pub, and shares in Tescos (whose alcohol sales have risen). You wouldn't stop there though, because statistics show a correlation between Pubs and Supermarkets so you'd invest in something not related to them (for example, gold and gilts) and spread your investment around. The more uncorrelated your investments, the better the diversification. It's a very simple concept.

What I think you are trying to illustrate is called Systematic (or Market) Risk and is caused by things like legislation changes, inflation rates, exchange rates, political instability, war and interest rates. This is just a risk you have to accept as in investor (and applies to gold too) but you can make educated guesses about the likely outcomes.

Unsystematic Risk is specific to a company, industry, market, economy or country; it can be reduced through diversification (i.e not putting all of your eggs in one basket)

Ok, I'll give you a working example of one of our portfolios for someone with a risk profile of 6/10, but first, you need to take a few things into account:

1) These are invested in collective funds. Collective funds invest in about 40-80 individual shares (different companies within the same area - e.g UK All Companies) so you already have some diversification there.

2) The different funds are (generally) invested across different geographical areas / sectors so you've got further diversification.

THIS DOES NOT CONSTITUTE ADVICE!

Ok, the funds:



You can see that over the last year, the portfolio has lost 7.64% (remember I said it was no guarantee for positive performance) but the FTSE 100 has lost 22.53% over the last 1 year.

Over 3 years, the portfolio has gained 18.04% whilst the FTSE has lost 2.24%. Just a footnote - investing in shares should be seen as a minimum of a 5 year investment

Now the diversification bit:

Ok, notice the asset allocation split. Most is in equities (shares), but there's a little bit in cash and about a third in fixed interest.

Next the Sector allocations show you where the money is invested (product areas) and the Region Allocation show which countries the portfolio is invested in.

Lastly, look at the top 10 holdings: You've got Gilts, Oil, Pharmaceuticals, Telecommunications and Banking (HSBC are largely unaffected by the credit crunch). These do not react to the market in the same way.

Finally, the performance over 3 years v the FTSE 100:


They've pretty much been the same until the start of the Credit Crunch a year ago, when the diversified portfolio has come into its own, outperforming the UK shares (FTSE 100).

That's just one example - your problem is that you're thinking on a far too small level. Across those funds above, there are probably 400 - 600 individually held shares spread across Europe, Asia, North America, Latin America, UK, Oceania. Within each of those areas, you then have further diversification; for example, China banks, China Mining Companies, China Textiles, UK Banks, UK Oil, UK Gilts.

I'm not going to waste any more time on this, because it's clear you know nothing about it and are arguing for the sake of it. I recommend you visit the following website for a crash course : http://www.investopedia.com/?viewed=1