Diversify Or Concentrate?

No matter how well designed mutual funds may be for a wide range of investment missions, sometimes a fund isn’t the best answer for your needs.

The prime virtue of mutual funds is the diversification they provide. That, along with other attributes like liquidity and convenience for small investors, makes them great candidates for a variety of purposes, ranging from growth investing to cash management.

But it may make funds less attractive in cases where you want concentration, not diversification, or in situations where diversification adds no real value. The first of those two exceptions applies mainly to aggressive investors out for sky’s-the-limit rewards; the second to conservative investors whose prime concern is safety.

Let’s suppose, for a moment, that you are a young, ambitious sort with a taste for adventure and a few thousand dollars in the bank. A couple of friends you respect invite you to invest your modest nest egg for a nice equity interest in the company.

Instead of opening a mutual-fund account at this early stage of your working life, you might make a better choice to plow your money into your friends’ startup enterprise.

The risks are many times larger. The probability of taking a total loss is certainly much greater. But the potential for big-time rewards is also a lot better.

A basic axiom in the financial world states the point succinctly: Diversification is a strategy for protecting wealth; concentration is a strategy for creating wealth.

Now imagine yourself in an almost opposite position. You’re well into your retirement years, so comfortably situated that your main concern is protecting your money from risks like bond defaults and dividend cuts.

To live well and sleep soundly, you decide to put the bulk of your money in U.S. government securities, spreading it over a wide range of maturities from three-month Treasury bills to Treasury bonds that don’t come due for more than 10 years.

By “laddering” your investments this way, you figure you can minimize the chance that you’ll ever need to cash in any security before maturity at a possibly depressed price.