| Diversification as an investment principle makes | | | | guaranteed because the rate of return becomes less |
| sense. However, most investors are terrible when it | | | | than current market rates and they often are less |
| comes to diversifying their portfolios. There are many | | | | than inflation or the cost of living in the first place. |
| different reasons why investors might shy away | | | | Greed |
| from diversification, but typically fear and greed at | | | | The other type of aversion comes from greed. Unlike |
| the most common arguments for why they do not | | | | the frightened or timid investor, those who are |
| practice the idea of diversification. Let's take a closer | | | | greedy when it comes to their investments might |
| look at what those aversions are and why they are | | | | stick to what they know and enjoy best, typically |
| not substantial enough to ignore the practice of | | | | equities or other higher risk assets that present the |
| diversification. | | | | opportunity for great long-term gains. |
| Fear | | | | The problem with being greedy is very well known -- |
| The most common instance of fear arises when | | | | what goes up must come down. This means that by |
| investors are afraid of certain asset classes, usually | | | | not following the principle of diversification, many |
| the equity or growth asset class because these | | | | investors are fully invested in equities because of the |
| assets present higher risks and the inevitable risk of | | | | attractive gains they have enjoyed in the recent |
| loss. Because investors fear this risk, they might | | | | past. This results in them ignoring safer asset classes |
| avoid this asset class altogether, which is a bad | | | | like cash and bonds, which provide regular streams of |
| move. | | | | income (however small) regardless of what the |
| By allowing fear to push themselves from different | | | | market is "doing." |
| asset classes, investors are not only missing out on | | | | Summary |
| the opportunities specific to that asset class (such as | | | | As noted here, the two most common deterrents to |
| capital appreciation and dividends), but they are | | | | diversification are fear and greed. By recognizing the |
| placing a lot of faith in the asset class they have fully | | | | cause of their aversion to investing in other asset |
| invested in. | | | | classes, investors are better able to tackle their |
| For a risk-averse investor who fears equities, the | | | | long-term portfolios with a greater sense of logic |
| typical investment will be term deposits and bonds. | | | | after they realize the true threats their fear and/or |
| As rates increase, however, those investments | | | | greed present. |
| become worth less, even if the principal is | | | | |