Concentration or diversification – which makes better investments

Common wisdom seems to suggest that you should diversify your investments.

But is this correct?

In my opinion, it is wrong, in fact, I remember reading Napoleon Hill's great book Think and Grow Rich many years ago where he also said that successful people specialise in one area they don't diversify.

On the other hand, you will find many financial planners telling you to diversify for your own protection.

What they fail to tell you is that it is also for their protection.

Since most financial advisors cannot tell you exactly which share or managed fund is a great investment, they tell you to buy a bunch of them.

Warren Buffett, one of the world's greatest investors, said:

"Diversification is a protection against ignorance.

It makes very little sense for those who know what they are doing."

Instead of diversifying, strategic investors focus on finding the best investments.

Averageness

In my mind diversification leads to averageness - the bottom of the best and cream of the bottom.

In my experience I’ve found that wealthy and successful people - be they business people, entrepreneurs or investors - have one thing in common, they specialise.

They all focus their concentration on one single earning activity.

They eventually became exceptional in that one activity by continuously improving their skills and increasing their knowledge in that one activity.

Despite the myth going around that it is good to have multiple streams of income the wealthy very rarely engaged in multiple earning activities.

I remember one astute colleague telling me “If I try to do five things to earn money, I will lose money in all five things. So I focus on doing one thing really well.”

If you look at anyone who has achieved great success and wealth, they have all focused intensely in order to win.

One of the reasons the rich get richer is because they are focusing, while the middle class is diversifying, and the poor are counting on the pension.

First, they concentrate, and then they reinvest

Another thing the successful people all had in common was that they reinvested the money they “earned” from that one activity into passive investments – most often real estate.

They kept building their asset base so that it would one day provide them "unearned income" - income they do not have to work for.

The lesson from this is to specialise and concentrate your activities on something you can become good at.

Then invest your income into high-growth assets building your asset base until you have your own cash machine.

You will never become wealthy by working for your money; you can only become wealthy if your money works for you while you're asleep.

Just to make things clear… once you become good at investing in real estate, there is no reason why you shouldn't diversify into asset classes, in fact, there are good reasons why you should, but first of all, become an expert at one thing.

I believe your "end game" should be to own your own home with no debt; have a property portfolio that is leveraged to a degree that it produces sufficient cash flow to at least service its debt; and have other cash flow-producing assets which could include commercial real estate, shares managed funds or superannuation.

So my suggestion is to become an expert in one asset class first (concentrate first), then diversify.

Risk mitigation

As your property portfolio grows in size here are some areas in which you can diversify:

1. Diversify lenders - Just as banks worry about "concentration risk" if they have lent you money for "too many properties", it doesn't make sense to have lender loyalty - spread your risks by using a number of banks
2. Diversify loan terms and types - Protect yourself from interest rate fluctuations by having some loans fixed and some with variable interest rates. if you only have one loan you can split it into both fixed and variable in most cases
3. Diversify your investments across different states to take advantage of their individual cycles
4. Tenant and property types - I own residential, commercial and industrial properties, apartments and townhouses

About Michael Yardney Michael is the founder of Metropole Property Strategists who help their clients grow, protect and pass on their wealth through independent, unbiased property advice and advocacy. He's once again been voted Australia's leading property investment adviser and one of Australia's 50 most influential Thought Leaders. His opinions are regularly featured in the media.