The whole point of diversification is to reduce risk, because if we are 100% sure of the gain in our choice, we wouldn’t need to insure ourselves against the possibility of loss. Alas, there’s not many events in our lives which we can be 100% sure we will come out positive and thus we employ various tactics to ensure that we do not lose everything that we have or to a certain extent, to at least protect what we’ve already gained.
However, diversification on its own is not sufficient. For instance, you set out with RM1 million to invest in start-ups which have no track records. The closest thing you can rely on is the personalities of their founders. You are given the option to invest a minimum of RM100,000 in any of the startups, or you can choose to invest the entire RM1 million in a single start-up.
In order to reduce your risk to the minimum, the ideal strategy is to spread out the RM1 million into 10 lots and invest them in 10 different start-ups and to ensure that all 10 start-ups belongs to very different industries. We also assume that the RM100,000 will give all 10 start-ups enough runway to last for the next 12 months, which should be enough time to proof the demand of their ideas with real paying customers.
If you think after signing the cheques to each of your investees is the end of the story, then you’ve missed the whole point of diversification. Spreading out your risk is only the first step, but by having stakes in 10 different companies, you also have an added advantage- the opportunity to learn from 10 different companies simultaneously. This does not mean you have to get your hands dirty and meddle with each of the start-ups. Instead, you now have a chance to get up close and personal with the development of the start-ups, observe the decisions that the founders make in the critical phase of their start-up, and most important of all- the mistakes that they committed during this period.
Only by actively monitoring and studying your diversified interest like a lab experiment would you be able to make the best out of your RM1 million investment, and having 10 companies to learn from is definitely better than just one.
Yet, there’s also the chance where all 10 companies is going to fail but if you have been taking notes during the entire process, you should have acquired enough experience to help you make better decisions in your next investment.
In short, while you diversify, you must also leverage on the opportunities to learn critical lessons from each diversification which you can apply on your future investment. Don’t just diversify for the sake of diversifying because if you do that, it’s no different from playing a game of roulette in the casino where you are just betting on sheer randomness.