Don't put all your eggs in one basket - critical take on the common wisdom

in investing •  5 months ago

If you've ever heard any investment advice, chances are that you've heard the "don't put all your eggs in one basket" or in other words don't invest everything in one thing. With this post I want to discuss why you shouldn't take this as an indisputable truth. I'll give you the good things and bad things about it. Whatever you might take away from this post, I'm by no means advising anyone to invest in only one thing or as they say "put all your eggs in one basket".

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Credit: http://401kcalculator.org

The good things related to diversification

The idea of spreading your investment among multiple investments (different stocks, different cryptocurrencies, or other investments) is called diversification. This term has become the number one advice given to anyone. There is no reason to doubt that diversification wouldn't increase your possibility to find a winning investment and there is no reason to believe that it wouldn't help to balance your investments in case one of your investments failed. These two things are the common sense ideas of diversification, which everyone should know.

By not putting all your eggs in one basket, it isn't so bad if one of your baskets falls, you still have the others. It is easy to see why this is a good idea. Especially if you're not quite sure if you'll be able to balance everything without something falling down. The idea has been taught for a long time and many swear by the effectiveness of the method. Everyone will tell you to do so. Most successful investors will tell you to diversify. Some even call diversification the only free meal an investor has.

When it comes to cryptocurrency trading, the vast and diverse amount of cryptocurrencies makes it really hard to decide which currency would be the best to invest in. The more you pick, the better the chance is that you pick at least one that will make you great profits. These are the good things with diversifying, put simply.


Source: http://maxpixel.freegreatpicture.com/Woven-Carry-Cot-Shopping-Basket-Baskets-Wicker-116760

The bad things related to diversification

Now lets look at diversification in a critical way. First of all, lets go back to the eggs in a basket metaphor. The awesome thing about this metaphor is that it adapts. Imagine you put one egg in one basket, now you have 20 baskets, instead of having all your eggs in one basket. Now, how easy is it for you to move them at once? How easily can you look after all your baskets? Wouldn't it be easier to have all your eggs in one solid basket, which possibly protects the eggs?

"What the hell?", you might ask, well as I said this metaphor also adapts. The less baskets you have, the easier it is for you to look after and take care of your baskets. The same goes for investments. The less investments you have the better you can take care of your investments. Now, if you had 20 eggs to carry, you wouldn't just pick the first basket you can find, unless you're in a hurry, but if you are, then you'd run the risk of picking a crappy basket, which breaks. Imagine you had the choice between buying a basket, or multiple baskets. You could either go for multiple baskets, or one basket. Obviously you have a limited amount of money, so you can only buy the basket that is super good because it is quite expensive, or multiple less good ones. If you're lucky you can also find a bargain and get multiple good baskets. The super good basket can fit multiple eggs so if you need more space another time, you can easily fit more eggs in there. The other baskets have a more limited amount of space. What kind of basket or baskets do you go for?

Well, I for one would weight the options, maybe there was one really good basket, which was more expensive, but I was sure my eggs wouldn't break in that basket. Or maybe the difference between the second best and the best weren't that big so I decided to buy two of the second best ones. But I knew carrying more than 3 or 4 baskets would start to be very challenging so I wouldn't buy too many. At the end of the day, I would be very happy with my purchase either way, because I used my time to investigate the best possibility.

Now the metaphor might not be easily relateable to modern life, but neither are investments easily relateable to everyday life. Therefore, you have to take your time to investigate what you buy. It won't help you to buy twenty baskets if you can't carry them all, or they have holes in them. Neither will it help you to diversify, because of diversifying. If you invest in multiple investment just because you heard you shouldn't buy just one, what you are essentially doing is buying multiple potentially bad investments, which might all fail or all win, but how would you know, because you just didn't want to put all your money in one. Do you see the problem?


Source: http://maxpixel.freegreatpicture.com/Wood-Basket-Egg-Natural-Product-Quail-Eggs-Broken-1235576

What should you take away from this?

I hope the metaphor helps to put diversification into simple terms. You shouldn't invest in things you don't understand or which might not work out. If you know that there is only one good option and the others aren't good, why would you invest in the others? Now I realize this is rarely the case. Most of the time people won't see a superior investment and know that, that is the one. Most of time you'll be balancing between two or three best options. Now that is when diversification is a valid option. That is how you should use diversification, not just to buy 20 shitty baskets because they were cheap. What do you do with those shitty baskets? Throw them away? Well that is exactly what you'll be doing, unless you get lucky and find out that you just bought the new Samsonite of baskets or whatever and all your friends suddenly want to buy one from you. How likely is that? Ask yourself this when you're about to invest next time: "Did you choose the best one? Are there other alternatives that you know would be good, or are you just buying a bunch because you don't know what to buy?". If you're about to buy a bunch because you don't know what to buy, don't buy any. Go back and look at the descriptions on the different investments and decide what is best.

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