Concentration or diversification – which makes better investments

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

But is this correct? How To Develop Your Property Investment Plan

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 – bottom of the best and cream of the bottom. property

In my experience I’ve found that wealthy and successful people – be they a business person, entrepreneur or investor – have one in 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, 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 provides 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 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

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Michael is a director 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. Visit Metropole.com.au


'Concentration or diversification – which makes better investments' have 13 comments

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    August 20, 2020 Ben

    I agree with Warren Buffett. But I wouldn’t use the word ignorance. I would say most investors are simply distanced from their investments, in that they can’t control the risk mitigation strategies being employed. In property, housing is not a homogenous market, and in reality any specific property development has a subtlely different market to any other by virtue of its location and other characteristics. Therefore a portfolio of “all” apartment buildings, for example, could be considered both concentration and diversification at the same time. We have to be careful not to think in a polarized manner about this.

    Reply

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    August 20, 2020 Val

    Totally disagree,I retired at 52 [12 years ago] and have investments across property,shares [40 plus companies] and hold some cash…..they all serve different purposes.You can NOT put your eggs all into one basket.By the way Buffet apparently still drives some POS car…….no point having money if you don’t know how to enjoy it.

    Reply

      Michael Yardney

      August 20, 2020 Michael Yardney

      Val, I agree that once you become good at something with shares property etc then you should start to diversify. And I definitely agree that having lots of money without being able to enjoy it leads to a very poor life.

      Reply

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    December 29, 2019 Chris

    I was always told to put your eggs in 1 basket, then watch that basket really carefully. Thanks for the validation.

    Reply

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    March 16, 2017 Alex

    Excellent advise! Actually diversification and specialisation will not contradict when done wisely. Specialisation means the property must fit well in the business model (if you indeed run your investment like a business). The diversification is a risk mitigation tool. You can still diversify staying within your market niche – for example one can specialise on properties appealing to young families / couples yet diversify by geography. So such diversification mitigates the risk of a down turn in one location. An example of foolish diversification is breaking your business model by buying properties of random sizes and types for the sake of diversity.

    Reply

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    November 14, 2014 Peter

    Hi Michael,
    What are your thoughts on diversifying property in different cities. All of our properties are in the middle ring suburbs in northern Brisbane. Do you condsider diversification within different capital cities a necessary strategy.

    Reply

      Michael Yardney

      November 14, 2014 Michael Yardney

      Yes Peter – as your portfolio grows think you should have properties in the various big capital cities because each has their own day in the sun – running in different cycles as this article explains: http://propertyupdate.com.au/capital-citys-housing-market-performs-differently-turn-sun-john-lindeman/

      Reply

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    November 12, 2014 John

    Hi Michael, I agree with your comments. However I think that this is fine in the accumulation phase of wealth building. In the consolidation phase a more prudent strategy is to diversify into more liquid assets as many financial planners will also tell you.
    Sometimes you just need the cashflow and as a necessity putting all your eggs in one basket is just not practical. As you say the wealth building is meant to replace income later on and when you reach this stage you must have the cashflow.
    This also holds true for those who need the peace of mind to sleep at night. Eg. All your assets locked up in one major share could prove devestating and that is why it is necessary to look at diversity.
    Regards
    John

    Reply

      Michael Yardney

      November 12, 2014 Michael Yardney

      Thanks for the comment John

      I agree that’s what most financial planners will tell you, but that’s why they are financial planners and general wage earners.
      If you asked Warren Buffet he’d explain why he only invests in a handful of companies

      Reply

        Avatar

        November 12, 2014 John

        Thanks for your reply Michael

        Again I agree with the general thread of your thoughts and the outcomes. I simply think there is a time when most of us have to put aside a bit more in different forms, just as you would a buffer for your investments. Sometimes all the logic and things on paper just don’t fit for the individual scenario and there will always be the extremes between those who are prepared to take the greater risks. This is why I am not a devotee of people using 100% of their money to buy a property in an SMSF. There will always be times where CASH is King. When your looking at retirement you have to weigh things up differently to what you would at 30. At 30 you can start over at 60 you don’t have that luxury.

        Mind you this is an individual opinion and I’m no Warren Buffet or Tiger Woods.

        Reply


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