Diversification is...

You know the cliche: don’t carry all your eggs in one basket. In finance, it means diversify your “holdings” or investments. 

But who wants to be the guy trying to haul around 5 different baskets? And even though I might split my eggs between 5 baskets, I still get scrambled eggs when I trip. And I have higher odds of falling if I’m trying to carry 5 baskets instead of just one. 

Honest question for all of you raising chickens: do you really follow that cliche advice and carry more than one basket out to collect your eggs? I would guess most days, you’re not even using a basket, but just folding up the bottom of your shirt. 

“So Wake is against diversification and cliches?! I knew this guy was a financial advising heretic!” 

Let me be clear for the purposes of truth and legal liability: Wakefield Hare is a proponent of the principle of diversification and uses it consistently for his clients. But there is a “but.” 

I think diversification is largely miscommunicated to and misunderstood by American consumers. Diversification is not the only way to invest. In fact, northwest Missouri’s collective net worth is likely undiversified. Today, farmers in our area have most of their financial well being tied to two commodities: corn and soybeans. 

I have personally felt the sting the lack of diversification in agriculture can cause. My dad borrowed to buy a hog farm just north of Savannah in the 1980’s. It was a solid hog operation, but the market for hog prices collapsed in the late 90s, which sank most of the hog farms in the Midwest. My dad was smart and diligent, but debt and terrible timing ruined his investment and put our family in a really tough position. 

My dad was not diversified. And when things didn’t work out on his single large investment, the consequences reverberated into areas of our lives you wouldn’t even guess had financial connections. 

Because of that experience at an influential age, you would think I would curse the idea that anyone would risk being undiversified with their finances and investments. But that is shallow thinking, because others, including many in our own community, have done very well by being undiversified. 

The issue isn’t diversification or non-diversification. The real issue is naivety to the risks at stake. When you are undiversified, you risk a single event sinking your entire investment. Are you truly prepared to lose all you own and “start over” financially midway or even late in life?

When you are diversified properly, you risk accepting much lower returns in the long run. Someone who bought a balanced, well-diversified portfolio of stocks 20 years ago has made less money than someone who only owned Amazon, Facebook, Apple, Dollar General….or even Monster Beverage stock. But a diversified portfolio would have done better if you had only been holding Wal-Mart stock.

What’s the takeaway? For most people, diversification provides essential benefits, but it’s not perfect and there are costs to diversification most are unwilling to consider. Being undiversified can be dangerous. But just because something is dangerous, doesn’t mean we write it off. Otherwise, none of us would ever leave our beds.