How to Protect Your Investment Portfolio

“Diversification is protection against ignorance. It makes little sense if you know what you are doing.”

– Warren Buffett

As investors, we could aspire to achieve what Warren Buffett has been able to do. As the chairman and chief executive of the U.S.-based Berkshire Hathaway Inc since 1965, the investing maestro has grown the company’s book value by close to 20% annually over the past five decades.

For perspective, this easily outpaces the long-run returns of the SPDR STI ETF (SGX: ES3), a proxy for Singapore’s market barometer, the Straits Times Index  (SGX: ^STI). Since its inception in 2002, the exchange-traded fund (ETF) has returned 7.21% annually through this October.

However, the hard truth is that not all of us can be as good as Buffett. Instead, we may want to swim against Buffett’s bold assertion above and diversify our portfolios to protect our own wealth.

Diversifying your portfolio

“Most people who end up not being successful as investors or quit investing — it’s because they have a bad stock or two, or they load up on something and then they swear the whole thing off as the market sells off in 2001 or 2008-2009. Don’t do that.”

– David Gardner, co-founder Motley Fool

For me, diversification is more about avoiding concentration, as opposed to trying to spread your money into every industry out there. It makes little sense, in my opinion, to get into areas which you are unfamiliar with, or know little about, for the sole sake of ‘diversifying’ your portfolio.

There are many different aspects to avoiding concentration.

If you had loaded up your portfolio with companies such as Keppel Corporation Limited (SGX: BN4)SembCorp Marine Ltd (SGX: S51), and Ezion (SGX: 5ME) at the start of 2015, your portfolio is unlikely to give the best yield.

That’s because the trio’s financial and business health is tied to the oil and gas industry. With oil prices falling significantly since mid-2014, the share prices of the trio are also down significantly for 2015. This illustrates the importance of avoiding concentration in industries. You need not invest in every industry available, but it doesn’t make sense to overload into something either.

We can also avoid concentration in time as well. In other words, we could consider diversifying across time. As long-term investors, our advantage lies in learning about companies over time and adding to our winners as we go along. By investing across a wide-spectrum of time, we give ourselves room to make use of the advantage.

Foolish takeaway

Investing can be about balancing the need for investment returns and risk management at the same time. Avoiding concentration in industries and time can help us manage that balance.

For more investing insights and to keep up to date on the latest financial and stock market news, sign up for a FREE subscription to The Motley Fool's weekly investing newsletter, Take Stock Singapore

Also, like us on Facebook to follow our latest hot articles. The Motley Fool's purpose is to help the world invest, better

The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chin Hui Leong owns shares in Berkshire Hathaway Inc.