Keeping all the eggs in any one basket can prove costly

Posted on November 1st, 2011.

One of the interesting tendencies that I noticed over many years of dealing with Canadian investors is the tendency for some to buy more and more of the same type of investment. In the investing world having too much of one type of investment is often referred to a having a “concentrated position”, and is generally considered a warning sign in an account. The reason being that if many of the investments are similar then there is a risk they could all do poorly in tandem.

I believe the reason that investors buy more of the same sorts of investments comes from the comfort of buying the familiar. Perhaps an investor was convinced to buy a preferred share for example, it went up a bit and seemed pretty consistent, so that investor bought more and more of them until they made up a significant portion of the account.

The investor who buys all preferred shares is subject to the risk that interest rates or market conditions change and impact the price of all these investments in a negative way, to a similar extent.

The income trust boom of the 1990s and early 2000s is a prime example of this, with investors buying these instruments up in droves. When the government announced a change in their taxation in 2006, the impact of having all the eggs in that particular basket became evident.

On the flip side an investor could purchase all GICs and government bonds for example, exposing themselves to a minimum amount of risk to their principal investment. While it is true that when purchasing GICs the risk to their principal may be minimal, what about the fact that they are receiving very little interest? Having a “concentrated position” in GICs could be considered costly in terms of missed opportunities!

I suppose if you are going to have large positions in investments then the safer they are better. It is certainly true that it is common that an investor will buy all GICs or government bonds. It is the investor with all real estate or all oil & gas stocks that are a greater concern in the short term. A negative price change could have enormous short term damage, whereas the damage from the low rates on GICs is more long term and gradual.

So what can an investor do to better diversify? In my acclaimed book: Insync Income, The Must Read Guide to Investing for Income in Canada, I suggest that a mix of income oriented investments, where the composition takes into consideration the current and upcoming economic environment, may be right for many income seeking investors. The book has been described by some industry folks as a “reference”, where someone can get info about the various income paying investments in Canada.

When it comes to making investment decisions education is key, but not a replacement for professional investment advice. I think that people who read my book will make better choices about whose advice to trust and I feel good about that. Invest with advice for best results.

Frank Weiler

The Income investor’s Advocate

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