Concentration and diversification

Investors need to balance concentration and diversification in their portfolios. The appropriate balance is based on your appetite for risk and how confident you are in your knowledge of what will happen in the future.

If you had perfect information about the future, you would concentrate all of your assets on the single investment with the highest return. However, because no one knows the future with certainty, people rely on diversification to reduce risk. (Another approach is to hedge). This way, they can still have an overall positive return even if they have some big losers in their portfolio.

In other words, if you don't have better information than everyone else, you should diversify. But, if through research you become confident in a contrarian point of view, you should concentrate your investment in that position to make the maximum return.