marc2Don’t have all your eggs in the same basket. That’s the saying. Don’t base your hopes for a financially independent future on one particular asset. It’s a sure-fire (!) way to lose everything you have ever saved. It will crush your dreams and hopes for early retirement. Not good!

A diversified portfolio makes you less vulnerable to the behavior of one particular asset. You spread the risk. And that’s what we want. We want no risk. And high gains.

But you can’t have both. You can’t spread your assets to become less vulnerable and still have all the benefits of owning that one top-performing stock. You have to choose. High returns, high risk? Or rather low risk, which will yield lower returns? Or something in the middle?

My portfolio is rather…concentrated. It consists of one asset. Not one type of asset, but one asset. My company’s shares.

My anxiety level seems to have a positive correlation with the value of my portfolio. They both move up in tandem. Initially I didn’t give it much thought, but as I invested more and capital gains increased, so did the stakes. I realized that – if I continue on this path – my investments would allow me to retire early. I have always dreamed of that, but it suddenly became tangible. Early retirement is within reach.

But it could also slip through my fingers if the one stock that I own crashes. Or would it? As I am pretty sure buying more or less random stocks just for the sake of diversification is a bad strategy, I want to understand things a bit better.

Should I diversify at all? And if so, should I own stocks in other companies? Across industries and sectors, local and global? Should I spread across different asset classes? How does one go about portfolio diversification? And are there any drawbacks?

Risk tolerance

Personal circumstances are key. A good strategy for one may not be a good strategy for someone else.

For instance, a younger person with an investment horizon of 20-30 years may be willing to take more risk (in the short term) than someone who is close to (early) retirement age (that’s me). And someone who invests a decent chunk of his salary in order to beat full pension age (that’s also me) may feel the stakes are higher than someone who invests $1 million out of a total net worth of $10 million (for the record, that’s not me).

What is my risk tolerance? How much risk  am I willing to take, how much uncertainty can I withstand, without losing sleep?

Investor profile

What are my goals? And yes, how risk tolerant am I?

I feel the stakes are pretty high. Mind you, when commuting to work I often fantasize heading to my favorite coffee shop instead, for a lazy morning drinking my favorite brew and reading a real paper newspaper. And I think about all the things I will do – and won’t do anymore – once I quit my job. And I even started a blog about early retirement – the one you are reading. Can you see how desperate I am?

But I need to be more specific. How much longer am I willing to work? How much money would I need to retire early?

I wrote a post describing the various scenarios: Financial Independence: Building your bridge.

My minimum requirement is what I dubbed the ‘classic bridge’.

bridge

It’s the scenario where I need just enough money to bridge the gap between early retirement and my full pension age. It’s also the scenario where I would deplete my savings (which is not my preference).

This minimum requirement puts things a bit in perspective. My investment horizon is about 10 years and I have a pretty good notion of how much money I need.

Also, in my goals I wrote:

If I retire in 2028 … and have to bridge 8 years until full pension age, I would have to have around $650K. If I subtract the $350K for my home and the $60K I already have, I am left with $240K to save. As I have more years to do that (10 instead of 6), I would need to make sure the value of my portfolio increases with $24K per year.

To reach the situation where I can retire at the age of 60, I will need to make sure the value of my portfolio increases with a minimum amount of $240K.

It reveals another thing. I consider my mortgage-free home to be part of my investment portfolio. I will be willing to sell in due time and rent a cheap place instead. It is therefore a portfolio diversification (so I was lying in the intro when I stated I only have company shares in my portfolio).

This has an impact on my risk tolerance. My home is a low risk, pretty high return asset and the passive core of my portfolio. I am willing to take (some) more risk with my other assets. Maybe I can generate some higher than average returns.

Having said that, I am sure my risk tolerance will get lower over time – the stakes will feel higher the closer I get to my early retirement age – and therefore will choose to move more and more of my money into a passive, low risk core with investments.

Diversify ‘company shares’ asset?

I obtain company shares via a so-called ESPP program (employee stock purchase program), allowing me to get them against a discounted price.

At the time of writing this post, the discount is 40% (it changes depending on the lock-in price – which is recalculated every 2 years – and the current share price). I invest 30% of my net salary so you can imagine it gives an enormous boost to the value of my portfolio.

But what should I do with it?

It appears to me I have the following options:

  1. Leave it
  2. Secure the discount-generated capital gain (re-invest, diversify)
  3. Sell a more significant percentage for diversification purposes

The discounted price is like a risk-buffer. Even a significant drop in share price would not necessarily mean I will end up with a negative capital gain/loss. That’s re-assuring.

Securing the instant capital gain (2) or selling even more (3) would be a good idea if I see no potential for further gains, don’t want to take risks and ‘cannot afford’ to lose it.

I definitely see a potential for further gains and I am willing to take some risk, but I have not yet decided what to do.  I am still sleeping at night though, so I probably wait a bit before selling.

What’s your view? Should I sell or not? I would love to hear your opinion, so feel free to leave a comment below the post!

Other assets

I plan on investing more money, but not via the ESPP program. As I think it would be silly to buy even more company shares, I will move towards a more diversified portfolio quite naturally (be it slowly).

How do I know what to invest in? I’ve read that an overly diversified investment portfolio could reduce potential gains and produce only – at best – average results. And also, when diversifying, I have to make sure to invest in assets that have no close correlation with the assets I already hold. If I were to buy shares in another company, but those would move in tandem with my existing company shares, I have done little to mitigate risk.

diversify

I feel I do not have enough know-how to make informed decisions about it (yet). But I have come across some options.

Index funds or index tracker

Index funds (ETF – Exhange traded fund) are a type of mutual fund. An example is Standard & Poor’s 500 Index (S&P 500). They’re designed to keep investing simple and for people like me, who have little knowledge about how to value businesses, it offers an easy way to access a strongly diversified basket of stocks.

The alternative of investing in an index fund is to handpick stocks for your own private index fund. But this could proof costly and what stocks would you choose in the first place if you don’t know how to value businesses?

Index funds don’t necessarily remove the risk of loss. But they’re low maintenance (passive), diversified by nature and offer lower risk compared to hand-picking stocks (if you don’t know which ones to pick).

Crowd lending

I came across crowd lending (P2P lending) as a new investment type a little while ago. It’s a construction where multiple individuals pool their funds together to fund a loan for another individual (or a business) – via commercial loan agreements.

There are quite a number of such crowd lending platforms, each of them having long listings with loans you can invest in. Returns 8% and up (depending on the risk).

The risks? The borrower could default. But many platforms offer buy back guarantees, which means you can get the principal amount back. The credit issuer (lender) could go out of business as well. In that case you’d probably lose (some of) your money.

To spread your risks you can spread your investments over multiple platforms and multiple loans. A default or even a credit issuer going bankrupt would not lock-up or destroy too much of your money.

I will give this a try, but if you have any experience with this don’t hesitate to enter a comment below the post.

Real estate crowdfunding

Real estate crowdfunding is another option that I am definitely going to look into. It allows you to pool together with other investors and get access to property bigger than you would be able to afford on your own.

Real estate can generate passive income, has low correlation with stocks, and would be a welcome diversification to my portfolio.

I’m definitely going to move some of my money into real estate.

Conclusion

I know there are many more diversification options, but I will dedicated some more posts to that in the future.

What I will do in the short term is aim for a natural, slowly increasing diversification of my portfolio in the sense that any new investments (not related to the company ESPP program) will be in lower risk, non correlated assets (non correlated with my company’s shares).

Most likely in real estate, loans, index funds.

A big part of my portfolio consists of my company’s shares and I am still not sure that’s the best option. Having said that, I sleep well. Apparently, my risk tolerance allows me to hold on to them for now.

What are your thoughts?

What would you do if you were me?

Have you been in a similar situation with a concentrated portfolio?

4 thoughts on “Diversifying My Portfolio: Yea or Nay?

  1. “As I am pretty sure buying more or less random stocks just for the sake of diversification is a bad strategy, ”

    For what it’s worth, I ran a 3-year experiment tracking 23 portfolios containing 5 randomly chosen stocks (my Monkey Stocks League)

    The top portfolio happened to have that one top performing stock and made an overall gain of 141%. The others showed an average gain of 29% over the 3 years. Five portfolios showed overall losses (but no more than -14%).

    I’m not recommending randomly choosing stocks is a great strategy but I’m not sure you can say it’s a ‘bad strategy’ 🙂

    With regards to diversification, if your only investments are in your company shares, then in your shoes, I would consider investing in some index trackers to spread the risk.

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    1. Thanks for your comment Weenie! Yeah, maybe it isn’t a bad strategy. But intuitively – for me at least – it doesn’t feel right to buy stocks of companies I don’t know much about just for the sake of diversification. I mean if I can’t value them, then how will I know they will produce a return? But your experiment is interesting. Did you pick all those stocks yourself? All randomly? And what was the overall return for all 23 portfolios combined?
      Remember that I consider my mortgage free home to be part of my portfolio. So currently, it is actually rather skewed towards real estate. But index trackers are certainly interesting and I will most likely move some of my money to those. Especially as I am closing in on ‘early retirement age’.

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      1. No, I only randomly picked my own portfolio, which I invested in with real funds – most of the other portfolios were randomly picked by people who attended a UK FIRE meeting. We drew the stocks out of the hat (bits of paper with the names of the FTSE 250 companies), so no stock was duplicated, which I guess wasn’t very true to life. The winning portfolio after years 1 & 2 used the Dogs of the FTSE strategy, the winner of year 3 had used the randomize function in Excel to pick his! One portfolio was based on Vanguard LS 60% and ended up at 34.8%, so a great result for passive investors. The overall return of all 23 portfolios combined was 30%.

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        1. That’s impressive! And it makes me think and reconsider… The Dogs strategy appears to be a really good method. I will look into that. I will not rely on randomize in Excel, but it’s impressive nonetheless.

          My company stock: Close to 300% since 2015. 36% YTD. My gains are significantly higher, as I obtain shares via my company’s ESPP program. For example, to have a negative capital gain for shares I purchased in January this year, the share price will have to drop more than 60%. Having said that, a possible strategy is to (immediately) re-invest the profits and move them to a safer, more passive asset. Index trackers for example.

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