In news out a month or so ago, Kodak exited chapter 11 bankruptcy in the U.S. after selling off almost 1,000 of the patents it have accumulated over the past 100 plus years as a company. Whilst Kodak hasn’t disappeared completely there is a long list of well known global companies that have fallen by the Wayside. In Australia, the GFC took a number of big names with it (ABC Learning, Babcock and Brown) and throughout time many other companies have disappeared even without a crisis (Ansett, OneTel….).
What this highlights to us is the need for diversification. Having a small investment in a wide variety of stocks, across sectors and countries means that when a company in your portfolio goes bad, and trust me you will always have a few, it doesn’t have a significant impact on your overall position or return. Take for example the Australian market, which is a highly concentrated market where the top 20 stocks generally make up over 60% of the market. The Largest stock, BHP, has significant exposure to two highly volatile drivers, Commodity prices and (ultimately) consumer sentiment in the U.S. and Europe through their exposure to China.
If either of these, or both of these, drivers were to fall then the profits and share price of BHP would be significantly impacted which, if you were only invested in the top 20 stocks across your portfolio would account for 10% of your portfolio. If on the other hand you had a diversified portfolio of global stocks and bonds, the impact would be much lower, plus you would have the added benefit of a much larger universe of companies working for you to offset the fall.
So if you were to take snapshot of your portfolio today, lets hope when you develop the picture your not holding to many Kodak’s!