Hello people,
Today I would like to discuss a very common question people always ask (In fact I asked myself when I first started) when you start investing in stock market. Now, you saw your friends earning thousands of ringgits in stock market and you thought 'Why not you also try buying some shares, who knows you could become the next Warren Buffet'? Right? So you saved up some capitals by taking out your savings, doing some part-time jobs, eating instant noodles and Whoops! You got your first RM10K and you prepare to march yourself into the so-called "money-making machine" stock market.
You will hear thousands of advice, news and suggestion all over the world, I don't plan to talk about all of them and I will just talk about one thing uncles and aunties always said: "Buy as many stocks as possible so you earn a little bit here and lose a little there, in the end you won't lose alot". Most people agree, but I don't. So, should you put your eggs in one basket when you invest or NOT?
So now you choose to diversify your money into different sectors (Banks, Plantations, Technology, Automation, etc). Whats the pros and cons of NOT putting all your eggs in one basket?
PROS
1. Lower risk as you invest in many sectors.
Most bankers, professionals always diversify when they do any businesses, investments to reduce the risk and volatility that is involved. It lowers the risk of losing all your money in the event of something unpredictable like airplane crash that affects aviation sector, or H1N1 flu that affects egg sector.
2. It improves your chances of winning
Through diversification by buying stocks in multiple sectors, it increases your chances of buying a stock that could be the next PENTAMASTERS or DUFU, in the other words, the next hottest stocks in the market. It offsets any losses in a stock by winning through other stocks.
3. Good for your heart
If you buy 10 stocks (10% of total portfolio each) in 10 sector, you might only lose out few percent when that particular sector crashes. You don't lose much of your money in a sudden event, hence you will have higher confidence as you face lower risks when you hold your stocks and it does not affect your mentality. Suitable for people with weak pyschology.
Cons
1. Chances of losing is the SAME
Although diversification improves your chances of winning, it also increases your chances of losing money. Your exposure to risks of the sectors doing bad is the same no matter how many sectors you buy in.
2. You are not Superman
Under any given condition, you NEED to do homework and analysis before buying a stock. If you are like me which treat stocks like a part time job, you won't have too much time to analyze every sector that you bought. A company's financial conditions, its prospects, management, income sources and possible risk that affect the company's bottom line, all these are required and not to mention news, quarter reports, annual reports that you need to take note from time to time. The only way of getting information is through speculations and news circulations from friends and most of these aren't even accurate!
3. You earn lesser
As you only put 10% of portfolio in each stocks, you also earn lesser money when a stock rally up. If you are like me which aims to achieve financial freedom through stocks investing, you might need to pray that all sectors that you invest in doesn't screw up. Winning consistently is more important than winning big. You might question, by diversifying my stock selection, i might win more consistently than ever. Well, point 4 will explain your doubt.
4. You won't be confident
As I mentioned in point 2, you can't possibly understand every sector in the market. Therefore, you are not confident whether the company that you bought is financially stable, has a good future income projection or high in debts. The best that you can get is a general idea for the company and most of the time you don't have any idea what leads to the rally or fall of the stocks. In the end, you don't know what made your stocks share price goes up or down, and even after years of investing you are only as good as a beginner who just started investing. That's not investing, that's gambling.
5. High brokerage and transaction surcharge fees
Most investors that buy 10 to 15 stocks trade very often because the reason they buy or sell is very dependent on news or speculations. They don't hold a stock for long as they always follow the flow of the market. There are three fees that is charged when you buy or sell a stocks which is: brokerage fee, stamp duty and clearing fees. Cheapest fee that you need to pay for each transaction (Buy & Sell) is RM20 including all the three fees and if you trade 20 times per month, you pay a whopping RM400 in just transaction fees! Sometimes you don't realize these fees cut up most of your hard-earned profits.
Warren Buffet, the greatest investor of all time said 'put all your eggs in one basket, and watch that basket'. By only focusing yourself on few sectors that you particularly prefer, you have more time and efforts to monitor your 'basket' and prevent in from falling down. You increases your chances of winning way higher because you understand the reason behind the stocks's price movement and you will only get better as time goes. To conclude all these, I strongly suggest newcomers to select one or two sectors that you like which is also trending up (Like technology sector), and select stocks from these sectors.
Remember, in the short run the market is a voting machine but in the long run it is a weighing machine!
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