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Tuesday, August 26, 2008

Your portfolio of stocks and mutual funds - why you shouldn't diversify

Investment analysts and the pink papers cry themselves hoarse about why investors must diversify their portfolios to mitigate risk and enhance returns.

This is another one of those investment myths that need debunking. Peter Lynch coined the term di'worse'ify about companies who enter unrelated areas of activities. The term applies equally well  for investors.

50 stocks or 20 funds in the portfolio is a classic case of di'worse'ification. Individual investors should try not to have more than 10 stocks or 5 funds in their portfolio. Otherwise it takes too much time and energy to keep track of the performance of individual shares and funds.

The richest individuals in the world tend to have extremely concentrated portfolios. Think about Microsoft's Bill Gates, Oracle's Larry Ellison, Walmart's Sam Walton, Infosys' Narayanmurthy.

While the average investor like you or me can't be compared with the legends mentioned, we can reduce risk and enhance wealth by placing a few concentrated bets on outstanding stocks. The key word here is 'outstanding'.

If you prefer particular sectors, avoid sugar or cement or real estate that give you windfall profits one day and huge losses on another. Concentrate on defensive sectors like FMCG and Pharma. You'll get steady and regular returns through price appreciation and dividends. And the downside will be limited.

So here is a formula for investment success. Buy a few outstanding stocks from the FMCG and Pharma packs - like Colgate, Hind Lever, ITC, Nestle, Glaxo, Lupin, Sun Pharma. These will provide steady returns and limit your losses during bear markets.

Balance such a sector tilt with stalwarts like Reliance, L&T, Bharti, Tata Steel, M&M. For a little extra, albeit risky, return add the odd Maharashtra Seamless and Opto Circuit.

Mutual Fund investors can buy a couple of diversified equity funds (like HSBC Equity, DSPML Top 100, Sundaram Select Focus), a couple of Balanced Funds (like HDFC Prudence, DSPML Balance) and an ELSS fund (like Magnum Tax Gain or Sundaram Tax Saver).

If you feel that such a portfolio is boring or uninteresting, then that is a very good indicator that you will make very good returns! For excitement and adrenaline flow, you can always visit Las Vegas or the Mahalaxmi race course!

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