The illusion of diversification

We all know that diversification is the key for investment or actually many things in life. For example,

a good case in point is our communications service providers in cellular and home/office internet connection. Last summer, the long network outage of Rogers cross Canada really taught us how essential connection is for our works and lives. It is necessary to use different service providers. One for cell connection and a different one for home internet.  The service providers love to offer discount for bundles to generate more revenue per customer and also make the customer harder to leave because it takes effort to change.

Even for simple saving accounts, we should spread our deposits in different banks just in case there is a bank run. It also helps to lower each deposit in different bank below the CDIC- Canada Deposit Insurance Corporation insurance limit. The recent US banking problem really illustrates how important this is.

When it comes to investment, many people think that investing in broad base index such as S&P 500 would give them enough diversification. I am afraid that it could an illusion. Many people keep doing the dollar costing averaging. However, it might not be the most beneficial way. It might be better to buy sector ETF. Since many sectors go ups and downs based on different economic cycles and certain business events. There might be more bargains than buying the whole index. Also, there might be more peak price points too. Owning the whole index in one fund, one has to sell or buy the whole index which doesn’t provide a lot of flexibility.

The other even worse idea is balanced ETF which combines the stocks and bonds. It changes the mix when a person gets older. More allocation to bonds gradually. This ETF usually has higher management fee because they are doing the rebalancing for you based on your age although it is a very simple algorithm with minimum cost. If someone is a bit more experienced investors, it is better to buy bonds and stocks separately for the same reasons above and avoid the higher fees.

However, for people who really wants to spend minimum time on managing their investments. This might be the way suitable. They are willing to sacrifice some return. Hope you find the right way to invest for yourself.