Posted on 02/26/2005 9:48:39 PM PST by SmithL
In graduate school, every finance student is required to take the diversification class. This class is sacrosanct among all school curricula, particularly in graduate school. Graduate school is where all aspiring young investment advisors learn the special answer to all investment quandaries: diversify.
When all else fails, diversify. If you're not sure what to do, diversify. If you're just getting started, diversify. If you're nearing retirement, diversify. If you're conservative, diversify. Aggressive? Diversify. If you hate your mother, want to lose weight, or drink too much? Diversify, diversify, diversify.
Following the precepts of the diversification class, a wise investor with a $100,000 portfolio will wind up owning thousands of individual stocks and probably hundreds of bonds.
He will own a number of different international stock funds, most of which hopefully will cancel each other out as far as currency fluctuations are concerned.
The real estate holdings will be spread among a single REIT if he's lucky; if he's unlucky, he'll own some horrible limited partnership a guy at church sold him. He'll be paying rent on his safe-deposit box to hold the two gold coins he forgot about. But he will be diversified.
When they don't know what to do, some people do nothing. Others do everything - a little of that, a little of this, and this and this.
One perennially successful investment manager, Marty Whitman, calls "over-diversification a proxy for knowledge - and a poor proxy at that."
When you diversify a portfolio to the point that you own everything, you've guaranteed mediocrity.
In college, if my friends and I couldn't agree on a specific cuisine for dinner, we would visit Duff's, the first all-you-can-eat restaurant I'd ever seen. If you couldn't decide what to eat, at Duff's you could eat anything - or everything.
But it all tasted the same. The macaroni and cheese tasted just like the green beans and the corn. There was no difference in the taste of the fish, chicken, fried steak, French fries or onion rings.
Everything was bland, but there was plenty of it. Nothing was good, but nothing was different. Everything needed salt and Tabasco.
I am often reminded of Duff's when I see portfolios constructed according to the teachings of the diversification class.
David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. He may be contacted by e-mail at david@mooncap.com.
Au Contraire - the efficient markets hypothesis would suggest that there are diminishing returns to holding more than 15-20 stocks. Well chosen, of course. Diversification reduces risk about as much as it can once you reach that number of individual stocks.
Which just proves that "to everything there is a season" and there actually is a "point of diminishing returns" to every doctrine!!!
>>One perennially successful investment manager, Marty Whitman, calls "over-diversification a proxy for knowledge - and a poor proxy at that."
When you diversify a portfolio to the point that you own everything, you've guaranteed mediocrity. <<
Fire this type of financial advisor ASAP
Diversify... choose industry specific mutual funds and diversify across them all.
While you're at it, drink red wine with a fish entree.
Interesting that no one actually connected this with Bush's stock index plan for Social Security...
Bill
Own a stock index. Instant diversification. Own a stock fund. Instant diversification. Own General Electric. Instant diversification.
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