Friday, 22 May 2020

(Post 175/Year 3 Week 33)TipforThought:To diversify or not? that's the question

Credits to GrandpaLemon from investing note for his wise words

Diversification: Is the Stock market similar to the arranged marriage?
Financial experts are keen to tell you to diversify your hard-earned money into a variety of assets such as stocks, bonds and real estate to get the best returns while hedging our risks but there is a powerful counter view. A short quote from Warren Buffett in 2008 (similar to his 1998 comments): "If you are a professional and have confidence, then I would advocate lots of concentration. For everyone else, if it’s not your game, participate in total diversification. If it’s your game, diversification doesn’t make sense. It’s crazy to put money in your twentieth choice rather than your first choice. Charlie [Munger] and I operated mostly with five positions. If I were running $50, $100, $200 million, I would have 80 percent in five positions, with 25 percent for the largest." And then a longer excerpt from the book about Charlie Munger's style: In the book Damn Right!, Buffett told Munger’s biographer Janet Lowe that Munger initially followed the fundamentals of value investment established by Graham, but was always far more concentrated than other traditional value investors like Walter Schloss: Charlie’s portfolio was concentrated in very few securities and therefore his record was much more volatile but it was based on the same discount-from-value approach. He was willing to accept greater peaks and valleys of performance, and he happens to be a fellow whose whole psyche goes toward concentration, with results shown. Munger defines “very few securities” as “no more than three:” Yet, as Mr Buffett once observed, such diversification can put an investor into an unenviable "low hazard, low return situation". Adopting Mr Buffett's approach goes against the grain of the mainstream investment strategy pioneered by Nobel laureate Harry Markowitz, who showed that diversification could reduce risk when assets are combined whose prices move in an inverse relationship with one another. But Mr Buffett is no ordinary investor and, unlike Mr Markowitz, who is an academic, he has walked the talk, turning his company Berkshire Hathaway into one of the world's richest investment firms by taking big stakes in companies that consistently outperform the stock market by big margins. Mr Buffett is also by no means the only exception to the rule. If we look at the portfolios of many other rich and famous investors such as Microsoft founder Bill Gates, we will find that they are also mostly concentrated on a few investments. Going back to the past 100 years, another good example would have been the great British economist John Maynard Keynes who was able to make a remarkable comeback by refocusing his attention on individual companies and taking huge wagers on them after losing a big fortune during the 1929 Wall Street stock market crash. As Keynes later explained: "As time goes on, I get more and more convinced that the right method in investment is to put large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes." Still, even though Mr Buffett and Keynes are big proponents of a concentrated portfolio strategy, one has to approach this strategy with caution. That is because while the strategy gives seasoned investors an excellent opportunity to maximise their long-term returns through a deliberate selection of stocks, investors who lack the skill to select suitable stocks can lose their shirts if they are not careful. So when should we turn to diversification as an investment strategy? As one gets older and more risk-averse, preserving whatever they have already squirrelled away is far more important than amassing more riches - and this is where adopting a diversified portfolio to try to preserve wealth becomes an over-riding priority. Another great investment guru, Mr Jack Bogle, the founder of the giant fund manager Vanguard, sums up this sentiment best when he observes that the average investor doesn't want to spend his life consumed with investing - and indeed, he should not spend his life consumed with investing. That is why a sound diversification strategy works best for those who simply want a decent return without exposing themselves to too much investment risk - or find themselves so obsessed with how their investments are performing that they are oblivious to everything else. Sure, all of us want to make money on our investments, but as our live phases change, so should our investment habits. How we adjust our investment approach will depend on the phase of life we find ourselves in.



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