Investment Diversification – Father Of Mediocre Performance

I believe that risk isn’t born of having all your eggs in a very few baskets, but rather from not knowing exactly what you’re doing — and where your eggs should really be. You’re never guaranteed success. So the next best thing is to use superior knowledge, research, and judgment to insure your baskets are the right ones.

So here’s what we’re going to do. We’ll give you a million bucks to invest for the future — your retirement. But we have some strings. (Well of course we do – like you’re surprised?) We insist that you limit the amount of money you can invest in any one asset. No matter how much it might be growing, or how much cash flow it generates, you can’t invest over the prescribed amounts. Even if it costs you hundreds of thousands of dollars in growth, you can’t violate the parameters. You must spread money around in order to spread risk. You may not invest more than 25% into any one asset.

And the different assets will often be contradictory to one another. Stocks, bonds, commodities, cash, and real estate. Or, precious metals, oil, wheat futures. Your pick.

Sounds a little artificial doesn’t it? The winged tip crowd calls it diversification. And they never say it without holding on to their suspenders, rocking back and forth on their heels, and looking over their glasses at you. I guess it sounds more credible that way. And if their hair is silver, all the better. It’s in the unwritten investor’s handbook.

Let’s climb aboard the ‘Way Back Machine’ and see what you’d do if you already knew the outcome. Of course, in the real world you’ll never actually know the outcome, because you’re not a seer. Your crystal ball is just as cracked as mine, right? Right.

You’re now back in the spring of 1999.

Would you have spread your million bucks into several baskets back in 1999 if you knew then what you know now? Not likely. You’d have mortgaged your home, your kids, and your soul to invest in real estate in San Diego, Phoenix, Boise, or any of the other regions that have more than doubled in value since then. You would have taken that growth and parlayed it into an impressive net worth by well timed tax deferred exchanges.

The financial definition of diversification is as follows: The practice of spreading one’s money among different investments for the purpose of reducing risk.

How it works in practice: The method by which an investor may guarantee a much lower return by spreading his money around into many different investments. This is an excellent technique for insuring relatively slow growth. It works better when investing solely in products available only on Wall Street. It works best when the ‘return’ is fixed at a rate barely higher than inflation. It usually makes the investor feel ‘safe’. That’s because he doesn’t know what he’s doing. If he knew what he was doing he wouldn’t be so fearful in the first place.

In sports we call that playing not to lose, as opposed to playing to win. If you’re setting up the defense for a football team, and it’s 4th down and six inches to go for a first down, what do you do? Do you defend half against the pass and half against the run? No — you put eight of your guys on the line to stop the run and the other three to watch out for the 5% chance of a pass. The 50/50 approach? That’s football’s version of diversification — playing not to lose.

OK, back to your million bucks. It’s for your retirement so you really want to limit the risk as much as you can, right? Ah, and there’s the rub. What constitutes risk? Ask 10 relatively knowledgeable investors and you might just get 11 answers.

Risk comes from not knowing what the heck you’re doing.

But don’t take my word for it. What two multi-billionaire investors define risk as not knowing what you’re doing?

Warren Buffett and George Soros. Arguably the two most impressively successful pure investors in the last 50 years — worldwide.

Fear isn’t productive, and will extract much of the return, or potential success out of anything. Investing can be compared to surfing in that to the degree you’re afraid of the shark in the water waiting just for you, it might just make an appearance, even if only in your imagination. Beware the Great White Diversification.

The investor who hasn’t lost money either started investing last month, or is lying. But in the final analysis it’s not really about the risk you take. It’s more about how much you profit when you’re right, and how much you lose when you’re wrong. If you know what you’re doing in a particular field, why would you ‘diversify’ into something about which you know little? Is it because you don’t feel safe unless part of your portfolio is providing ‘balance’ by just lying there? A Folgers can buried under the morning glories in the back yard will serve that purpose.

Remember, knowing what you are doing, really knowing — reduces risk substantially. You have to decide what you know how to do. If it’s real estate, great. If it’s mining you know about, invest in mining stocks. Investors fear losing because they know deep down they don’t really have the minimum required know-how to make prudent decisions. To make up for this deficit they buy a little of everything, hoping that if one crashes, its ‘opposite’ will rise, avoiding losses. Sometimes they just don’t invest.

Diversification is why the average 55-60 year old man has less than $60,000 in his 401K or IRA. When he hits 58 and realizes the reality of the retirement headed his way, panic often ensues.

It’s called playing not to lose, and isn’t a winning strategy for an abundant retirement. If you don’t believe you have the necessary know-how in something, then find somebody, a professional, who does. You may have money to invest, or you may have equity to tap. But what you don’t have under your control is the passage of time. Your retirement is coming at you faster each day.

Does that thought put a smile on your face?

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