Investment Diversification? "Diversification is for idiots!"
Mark Cuban: "Diversification is for idiots." (Video)
Warren Buffett: “Diversification is a protection against ignorance.”
Diversification has long been hailed as an essential safeguard against risk exposure to individual markets and assets, and a key part of the value proposition of mutual funds (especially Index funds).
That's how I was raised and taught. From my Father, from my professors, from most main stream economists. But it appears that there is a strong community of believers who think that "diversification is for idiots."
A friend of mine made this comment on this morning's hike, explained to me his logic, and went into the beliefs of very successful people who feels the same way.... and I'm buying in to the idea more and more. Diversification is most often discussed in terms of owning stocks, mutual funds, and index funds... all of which are in the same asset class, paper assets.
First, let's go over the 4 asset classes as defined by Rich Dad:
- Business: Owning a business which creates value and generates returns.
- Real estate: Commercial or Residential properties that generate rental income.
- Paper assets: Stocks, Mutual Funds, Bonds, Notes, etc.
- Commodities: Physical materials that have intrinsic and application value, such as Gold, Silver, and industrial products such as oil, rhodium, and iron. Many say that cryptocurrencies fall into this category too.
Most people are only invested in Paper Assets (mainly through their 401k) and sometimes Real Estate. When most people think diversification, they think "I have stocks in many different companies in many different markets, as well as index funds, that means I'm diversified and protected from risk!" .... yeah, about that... you are still only within one asset class.
"True" diversification is having investments in multiple asset classes. My friend is an entrepreneur like myself (business, check), owns rental properties (real estate, check), and puts money into his IRA (paper assets, check). He's not so much a fan of Gold or Silver, and doesn't plan on it because of fundamental issues with things that only store value and don't create value... with then exception of owning some BTC and ETH.
As we hiked to the top of the mountain after defining "true diversification", we went over the next level of diversification, being in different markets in each asset class.
- His business and his real estate portfolio are fairly focused in one geographic area, California. He has goals of owning Turn Key Rentals across the nation, in Texas, Tennessee, and other states to hedge his risks against California laws, taxes, rental demand, and real estate value fluctuations. (True that this is still limited to the US and power of the US Dollar, but international investing is a different ball game).
- He'd like to expand his business presence outside of the region as well, but has no intention of getting into different kinds of business (you only have so much energy and expertise, better to be a subject matter expert than a master of none).
- His IRA, he's focused on a few high dividend stocks, some mutual funds, and a few index funds, but after looking at his portfolio he realized that most of his investments were tied directly to the US market with limited international exposure. That means he wasn't taking advantage of a strong US dollar to purchase foreign stocks or the higher growth rates of the emerging market. Hopefully that will change soon.
- Gold and Silver holdings... He'll still pass on these. He does have a small position in BTC and ETH but isn't ready to take a chance on any Alt-Coins.
So, are you "Diversified" across asset classes? How so? I'd love to hear your take on this investment strategy/mentality.
One of my investing coaches always says "Diversification is the enemy of great returns". What he likes to do is to pick a theme that he believes will do well and lean his portfolio that way. (His words). I have to add that he was under 40 at the time with at least 20 years of working life ahead.
Now the basis of Modern Portfolio Theory is that you can eliminate specific risk by building a portfolio of assets. That leaves behind systemic risk only. The art of doing this lies in the pool of assets you are talking about and my coach always looked at 4 main classes of assets: property, stocks, interest rates, commodities. It was before the times of crypto.
In my investing I have brought the two things together somewhat. I do own real estate (a house that I could live in if I needed to). My stock portfolio leans very heavily in a few directions (Europe, Japan, Emerging Markets, Specialty metals, Banks, Insurance companies, Oil). I am leaning away from interest rates with only two bonds and a lot of shorts on interest rate futures. I hold multiple currencies which are somewhat hedged against my own currency getting weak. I do hold gold and platinum as a systemic hedge. Lastly I have built a large crypto portfolio which is dominated by STEEM. I am diversified here in altcoins because I do not know which ones will turn out winners.
I have survived 3 great market collapses. Sure do hope the next one does not prove my undoing
I think you have a solid portfolio with risks divided up within asset classes, yet focused on areas that you understand or at least strongly believe in.
The current state of the world economy sees "hot". Continual upward movement with few corrections. I thought the Chinese stock market correction would have been a catalyst for a global correction, but that was short lived. A credit collapse? Exposure of manufactured inflation through excessive printing of money? War? Something has to happen, just not sure when and where and how to hedge against the possibilities.
I think when most people give the "diversification" advice they do mean within an asset class, and even then they're usually talking about stocks. Although a real estate investor can diversify also by owning rentals in different areas like your friend is planning to. (Side note, if he hasn't already heard of Morriss Invest he might want to check them out... I haven't worked with them yet but I probably will be within the next year.)
I'd also argue Mark Cuban is pretty well diversified, owning multiple businesses and sports teams and Warren is famous for his stock portfolio but has also talked about owning farmland.
So yeah, I don't know what precipitated these well-diversified guys to say diversification is dumb... but I don't think it's a particularly bad idea to hedge your bets a little. I'm mostly in real estate though except for my 401k and a tiny bit I've gambled on cryptos (of which only Steem has paid off so far!)
Its a combination of diversifying within one asset class, or diversifying simply for the sake of being diversified (many times this leads people to invest in things they don't understand... WB loves sticking to things he understands), or diversifying businesses outside your skillset... which divides your focus and could lead to under-performance. I don't think they think diversification is bad across the board, but it requires a solid strategy and methodology.
I am the complete opposite of diversified. I stopped investing in my IRA, I have no stocks, no bonds, no mutual funds. I invest in my business and real estate. I recently invested in some crypto currency but mostly for fun.
You stick to things you know and things you can control. Stocks are investments that are out of your control which is a big reason many of my Real Estate driven friends avoid them (a view shared by Robert Kiyosaki of Rich Dad, Poor Dad).
The one reason I really like IRAs and am a strong supporter of them is that IRAs are guarded against most lawsuits and bankruptcies. A good thing if you're a big risk taker in real estate, such as taking out construction loans on spec builds.
Thinking a bit more about diversification, are you diversified across various real estate markets outside of Colorado?
I followed you until you just redefined diversification and told us to diversify ;)
In the end, it depends on your resources, but my experience tells me it´s sometimes way better to don´t diversify at all and concentrate on one thing you really believe in.
Diversifying is a way to play it safe and there are many good arguments for it - I know...
But take the crypto world for example - if I believe (just as an example) in projects like EOS and STEEM, why should I also invest in Bitcoin and Ether. Just because it´s "logical" to own the top 2 cryptocurrencies and to play it safe? No, I did my research and I 100% believe that they have the biggest potential in the market - so my funds go there and nowhere else until something convinces me otherwise.
This may not be the most "professional" way to approach things, but the moment I diversified my attention and energy in my past life, I learned, that it is always better to concentrate on one thing/project and stick with it.
Ironic considering your bio starts with "Embodiment of contradiction" :-P
Diversification is a touchy subject I'm finding. I personally believe in systematic diversification of investments, while focusing your primary energies in your career/business. Real Estate is awesome, but if it isn't your career/business, it's best to exercise patience and be very selective about the deals you pursue. Investing in paper, same thing, be calculated about it and stick to areas you know and understand. Commodities/Cryptos... not my area of expertise, invested a bit as a learning exercise, but agree with you that researching the coins available and investing in ones you feel have the biggest upside and strongest business case is the best approach as opposed to having a sporadic portfolio of hype coins...
None the less, thanks for the comment. I may have to follow up with a "Shiny Object Syndrome" post.
See, even my bio is contradicting what I´m living! I´d call that crazy wisdom and pure authenticity! ;))) Thanks for your insights!