by Robert Lalor

Created on: June 22, 2010   Last Updated: June 24, 2010

Let our time be represented by a knob of butter and let each investment we hold be a slice of toast.  If we have a diverse portfolio covering many different shares in lots of different industries then by the time we spread that knob of butter over all our slices of toast, the amount of butter on each slice will not be sufficient and we will have spread our butter far too thinly. 

In investment terms we will not have spent enough time on each investment and we will not have enough knowledge in each investment to be sure of the risks involved.  If we spend enough time analysing a company and checking every detail of its financial past and present, then unless we have done a poor analysis we should not be caught out. 

Sure there are events that are unexpected, which don't conform with the norm such as September 11th grounding planes and the BP oil disaster, but even these can be expected to a certain degree; it is not infeasible for planes to be grounded for a short amount of time and its not unusual for risky oil drilling to go wrong. 

What matters is whether such companies have the cash-flow to get through such events.  If an airline company or oil company does not have sufficient cash-flow to get through a potential disaster that whilst not expected is still feasible then you should not be investing in it.  In approaching these situations we can take two approaches. 

The first is to analyse the company in great detail and consider what events may occur and which events have occurred for similar companies and consider whether the company we are investing in has the resources to ride out such a problem; if there is a chance that an event that happens once every 25 years would bankrupt a company then perhaps this is not a wise share holding to add to your portfolio. 

The alternative, or second, strategy is to diversify to cover this risk by spreading your money as far as you can.  The problem with this is that if the situation does occur, you will be unable to determine whether the company can ride out the problem or whether it is going to be a fatal problem.  The time to do such analyses is not when the share price is tumbling, because invariably you're going to be a rabbit in the headlights.  Do enough analyses and enough preparation for potential, yet unlikely, situations and you should be fine; you may even manage to profit and increase you're share holding by responding to these situations in a planned

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