Time and again, despite knowing that putting all your eggs in one basket is a bad idea, investors lose money by chasing high returns or taking a gamble on a supposed ‘sure bet’. In the current environment of low returns, it is very tempting to look for opportunities to increase returns. This particularly applies to retirees who are struggling to make ends meet having seen their interest income fall to about one third of what it was prior to the Global Financial Crisis.
Investment ‘baskets’ operate at two levels. At the highest level is the split between different investment types (asset classes), such as cash, fixed interest investments, property and shares. At the next level, there are specific investments, such as individual bonds, properties or shares which fill each of the baskets. Investors who select a number of specific investments in just one asset class, such as fixed interest, are in effect putting all their eggs in one basket. The classic example of this is investors who spread their money across several finance companies in the belief that this would reduce their investment risk.
There is a key difference between investment and speculation. A speculator is prepared to take high risks for the possibility of extraordinary returns while an investor seeks a balance between risk and return and preservation or growth of capital in the long term. These are exactly what diversification provides.
It is difficult to predict which asset classes will provide the best returns in the short term. Chasing short term returns by trying to pick winners almost invariably leads to a poor outcome. A safer approach is to spread funds into different baskets knowing that some will perform better than others in the short term but there will be balance between risk and return in the long term.