Your grandmother likely told you: “Don’t put all your eggs in one basket.” It sounds like sensible advice until you think it through. If you return from the market, you can split your eggs between two bags but–assuming you don’t need to grow a third arm to carry them–what if the eggs have all gone bad? What if your bags are made from the same cheap paper and both tear?

Take Grandma seriously but not literally: she probably had something else in mind. But if she’s thinking about your investments, the metaphor is controversial. On the other end of the table, Uncle Warren may counter: "put all your eggs in one basket, and then watch that basket."

So who’s right?

Diversification may not be as cherished as motherhood and apple pie, but mentioning it won’t get you disinvited from the block party. The question remains: is the case for diversification obvious? Why should you want it, what does it even mean, and how can you achieve it?

If you’d held Amazon stock for decades, you could have achieved generational wealth. What’s the so-called high-class problem? Here’s one: you–actual you you “pre-incarnated”**--might have sold your stock when it was down 95% during the dot com crash***. Here’s another: what if your high-conviction stock was Cisco Systems instead? After that stock’s near-death experience, you needed 25 years to get back to even (this year). Which one did you or your alter ego buy? Are you a better stock picker than Uncle Warren?

Alright, you say, I take your point, but what if I buy more eggs: say 20 or 40? There’s no denying you'd be more diversified, but there’s a lot riding on your choices.  there’s an xxx chance you did 30% better than a broad market index (“all the eggs”), but an equal chance you did 30% worse. A portfolio like this comes with much more risk than most investors realize.****

But even if you’d owned (say) 500 stocks, it wouldn’t have prevented you from seeing half your wealth disappear during the 2000 Tech Crash or the 2007-2009 Great Financial Crisis. Those who lived through those episodes felt like they just owned a bunch of eggs and wished they had more ways to diversify their portfolios.

If you’re warming up to the “why” of our argument, let’s move on to the “what” and “how.” Simply put, diversification implies a difference: your portfolio needs to hold different assets that rise and fall at different times. It should give you smoother returns and help you compound wealth with less drama. You can sleep better at night knowing there'll be something in the kitchen for breakfast.

Before you get on board the diversification train, let’s bury a piece of ivory-tower lore. Diversification may be one of the best things in life, but it’s not free. If you own different assets, your basket will always be doing worse than its best performer, and you’ll sometimes be doing worse than your neighbor. If you’re willing to accept this price and own a thoughtfully diversified portfolio, you’ll enjoy both a smoother ride and a better destination.* (1+1>2)

Let’s bury another myth: that bonds are the best way to diversify a portfolio of stocks. If that’s a shock to you, reach out and we’ll be happy to shovel some dirt on the coffin.

Diversification is an obsession at Magnolia: as strong advocates, we’re constantly looking for better ways to articulate it and deploy it on behalf of our clients. For our latest and best thinking, please reach out to us.