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Should you diversify with stocks you don’t like? – Diversification downsides

diversification downsides

Diversification is a foundational piece of any well-rounded, balanced portfolio, and advice echoed by experts and investors alike across industries and disciplines. It’s a key component of risk management, and something that every investor needs to implement differently based upon their own situation, preferences, and needs.  

It’s hardly a controversial topic of discussion, but it does beg some other questions that often go unanswered when we’re vaguely told to “just diversify” or something along those lines. 

One of the most important questions to ask before doing so is this – should you diversify with stocks you don’t even like? What are the diversification downsides? Is it still prudent risk management if you don’t like the company you’re diversifying into? Let’s answer that. 

Diversification doesn’t ignore bad businesses

Diversifying doesn’t mean to simply pick a company you believe to be subpar just because it’s in another industry, and therefore subject to a different kinds of risk and different odds of success. No, in fact, doing this would undermine the entire goal of diversification, which is to mitigate risk while providing reasonable upside by getting exposure to different sectors and companies. 

If you force yourself to adopt a stock you don’t prefer just for the sake of getting some diversification in your diet, this could be a mistake, and potentially open your portfolio up to even more risk due to holding a company you find to be undesirable based on your criteria. 

So, should you diversify into stocks you don’t like? In short, no. Let’s first have a look at some examples: 

Reasons why investors might dislike some financial assets: 

Top Tobacco Stocks by Market Cap

Financial Reasons: The stock is too volatile or too passive/long-term. When investors seek to diversify, they do so for different reasons, but in almost every scenario, a desire for diversification comes with an equal desire for stability. If a stock is simply too volatile for your liking, it’s entirely reasonable to cross it off your list of consideration. Additionally, some investors may only want to diversify for a short period of time or in a certain market cycle. If this is the case, any equity that seems like it might take far too long to produce viable returns could be feasibly eliminated as well. 

Philosophical reasons: Investors might go against the industry as a whole. For example, The tobacco or gun industry. Although some investors might not care, if you’re someone who can appreciate investing with your morals in mind, there are a lot of valid philosophical reasons to avoid divesting into certain businesses you simply might not support. Investing this way can give you a peace of mind that comes with knowing you’re only investing in businesses you’re ethically okay with. 

Related: Why should you diversify when investing in ETFs?

Ways of diversifying

Nevertheless, it’s worth mentioning that most investors don’t venture to try and diversify by picking out individual stocks anyway, and that’s usually something left for traders or those who have a strong belief in a specific company. 

Although picking single equities in different industries is certainly one way of diversifying, it’s far from the most popular one, and there are likely better methods. 

Such as? Investing in broad funds that hold tens to hundreds of different stocks is by far the most common way modern investors achieve diversification, and this method takes out the hunting and pecking for good companies associated with single stock picking. 

This way, not only do we simplify the process as a whole, but also avoid the potentiality of investing in a business we might not like individually. 

Overall, it’s up to the individual. 

How you choose to diversify your portfolio, and to what extent you do so, is an entirely personal decision based on you and your situation. However, it’s still prudent to take into account the guidance of others and traditional means of doing so with a grain of salt, and apply your own preferences to those suggestions. 

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