The standard advice is:
- That a prudent investor should hold a diversified basket of assets which react differently in different economic environments (uncorrelated)
- That this strategy provides for less volatility and smoother growth
It’s not the truth.
But it’s not false either!
Logically if I knew what the top performing asset class, market or stock was going to be in the next 12 months then diversification could go jump in a lake, 100% of my money would go to the best one.
Some of the great investors do not diversify; they make big investments in a small number of holdings because unquestionably it’s the way to make the biggest returns and they back themselves to get it right.
The problem to identify these gurus is that it’s only later in their careers that their consistent brilliance becomes clear, many more start the race than finish (see the numerous hedge fund blow ups as testimony to that).
So why diversify
The truth is simply we don’t know what’s going to happen.
Chaos Theory explains that small initial variances cause outcomes to be totally and randomly different over time.
So we apply the Munger mantra of wisdom being the knowledge that we actually don’t know much in general and very little about specific future events.
We can accept that some stock markets had a great 2013 but this was not predictable at the beginning of 2013.
The portfolios do all invest in equities but not exclusively, they also invest in bonds and property and commodities, all of which did less well than equities last year but we could not have predicted that would be the case either.
We understand that people question the performance of diversified portfolios in periods of strong equity gains because they are not producing equivalent performance; we also know they will like them better when equities have a bad time.
Being the house
The question we ask ourselves is this.
Do we want to try to be the Casino or the Gambler?
The casino wins slowly because the odds are on its side, the gambler guesses, sometimes winning big but in the long run losing bigger because the odds are not in his favour.
If we could predict what’s going to happen we would be all in on the next winning card or number, because we can’t (and by the way no one can either) we diversify with a portfolio, we play with the odds on our side.
Some say they can beat the house, some get it right for a time and virtually all of them end up losing a ton. If they say they ended with a small fortune, it’s only because they started with a large one.
Get rich slowly
In years when equities shoot out the lights, everything else looks pedestrian and investors want in on the action; it’s human nature.
The fact that fewer than two years ago equity markets feared a Euro meltdown and plummeted, or that five years ago stock prices halved in value during the financial crisis, are forgotten. Returning confidence and the chance of making money tend to trump memories and past fears
Diversification in the best investments in multiple asset classes rebalanced to buy the laggards annually is a proven strategy to get rich slowly; it’s about being the casino.
Trying to ride the next hot market or stock is nothing more than gambling on a horse or a card and the chances of consistent success can be summed up as follows.
There are two Hopes
Bob and No
And Bobs gone home
NOTE: This is written in a personal capacity and reflects the view of the author. It does not necessarily reflect the view of LWM Consultants. The post has been checked and approved to ensure that it is both accurate and not misleading. However, this is a blog and the reader should accept that by its very nature many of the points are subjective and opinions of the author. This is not a recommendation to buy any product or service including any share or fund mentioned. Individuals wishing to buy any product or service as a result of this blog must seek advice or carry out their own research before making any decision, the author will not be held liable for decisions made as a result of this blog (particularly where no advice has been sought). Investors should also note that past performance is not a guide to future performance and investments can fall as well as rise.