It pays to put cash into different pots

Change is inevitable. Dr Benjamin Holdsworth shows why diversification in your investments will mean not missing the next Amazon.

When one looks into the future, it soon becomes apparent that a crystal ball would be useful. Unfortunately, they are in short supply.  

At times of economic uncertainty such as this, it can be tempting to run ‘what if’ scenarios in our heads, such as ‘perhaps I should move into tech stocks and pharmaceutical companies, as surely these sectors will do well’ or to pick out specific companies that appear likely to thrive in the future.

Two challenges exist. The first is that you will not be the first person to have thought this and these views in aggregate are already reflected in market prices. 

The second is that, in making such concentrated bets, you have a high chance of being wrong and missing out on the companies that end up driving future returns. Remember, 30 years ago Amazon did not exist. 

To get a feel for what these concentration risks look like, academics are fortunate to be able to dig around in a vast bank of historic stock market data in the US, known as the CRSP database (the Center for Research in Security Prices).