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* Diversification is a consequence, not a goal


Ben Graham
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DIVERSIFICATION IS A CONSEQUENCE, NOT A GOAL

 

Always keep in mind that wealth isn't static. An individual is either making decisions that will make them wealthier or less wealthy in the future. Both action and inaction are decisions - either have the ability to create and destroy wealth.

 

This brings me to why I dislike mutual funds. Aside from their ridiculous fees, I cannot trust the fund manager to do the right thing (which is often nothing). Fund managers are incentivized to always 'do' which has a high chance of ensuring absolute mediocrity if not outright disaster.

 

The idea of diversification is sold to the public as a goal. It goes like this: in order to minimize the risk of one asset collapsing in price, an individual should buy a wide variety of assets. In the event that one asset class falls in price, it will be offset by another that rises in price. The shoe also fits on the other foot: in the event that one asset class rises in price, it will be offset by another that falls in price. However, for some reason this other shoe is rarely mentioned by the companies that promote diversification.

 

This idea is very harmful to your wealth. Diversification is a consequence, not a goal, of investing. What does this mean? A value investor will always look to asset classes that have fallen in price. Over time a number of different asset classes will be amassed in an investor’s portfolio – stocks, real estate, royalties, bonds, etc. When another individual looks from the outside in, all they see is a well-to-do individual with a bunch of different assets. Unfortunately most will then jump to the incorrect conclusion that rabid diversification must have been responsible for the investor’s success.

 

Another side product of the mass marketing of diversification is something call asset allocation. The idea is that an individual should allocate their capital based on their age, tolerance for risk, yadda, yadda. This is a terrible idea. The glaring problem with this is that not all assets are good investments at the same time. Just because an investor has cash now doesn’t mean that they should start allocating a certain percentage to bonds, stocks, etc.

 

In short, if you have a strong desire to underperform, then diversification and asset allocation are your tickets to mediocrity.

 

http://www.ticonline.com/

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