The Role of Diversification in an Individual Stock Portfolio

by Vitaliy N. Katsenelson

It is frequently said that diversification is the only free lunch an investor will ever get, as this risk-reduction strategy doesn’t need to lead to subsequent reduction in return. Or does it?

Warren Buffett disagrees: "Diversification is a protection against ignorance. It makes little sense for those who know what they are doing."

For individual investors managing their own portfolio of individual stocks, both statements are correct.

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Vitaliy N. Katsenelson , CFA, is a portfolio manager with Investment Management Associates, based in Denver, Colorado. He is also author of “Active Value Investing: Making Money in Range-Bound Markets” and he maintains a Web site at .


John James from Texas posted 26 days ago:

Those that think being diversified in the stock market offers overall protection of their nest egg from the "falling knife" are wrong. I am 68 yrs old and have been investing in stocks and other non correlating assets since I was 21, and all my stocks bombed in every major recession, some more than others, in the general range of 35-75%.

While its true that younger investors will have time to recover, senior investors do not. Nor do investors who have an unexpected immediate need for money right after a severe recession.

The point is there is a bigger picture than just diversifing stocks and sticking a higher percentage of bonds in the mix according to age, as what investors are often told is all they need for protection. If one looks at a table of stock non correlating asset types, one can see that bonds are not the total answer to the problem, which is not that simple.

Equities and all asset classes that correlate with them at a hi rate and duration, need to be offset with non correlators like cash, long term bonds, gold and silver,currency futures, and utilizing short trading,other hedge options,and others.

That is true diversification.

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