Comments on: The allure of diversification … http://7million7years.com/2008/12/19/the-allure-of-diversification/ How to make 7 million in 7 years ... Sat, 11 Feb 2012 22:32:23 +0000 hourly 1 http://wordpress.org/?v=3.3.1 By: If you can manage risk, don’t you deserve a better return? « How to Make 7 Million in 7 Years™ http://7million7years.com/2008/12/19/the-allure-of-diversification/comment-page-1/#comment-2109 If you can manage risk, don’t you deserve a better return? « How to Make 7 Million in 7 Years™ Thu, 05 Feb 2009 08:30:56 +0000 http://7million7years.wordpress.com/?p=886#comment-2109 [...] risk, don’t you deserve a better return? Published February 5, 2009 Rich Diversification is an example of a risk management tool … I take exception with it because the financial [...] [...] risk, don’t you deserve a better return? Published February 5, 2009 Rich Diversification is an example of a risk management tool … I take exception with it because the financial [...]

]]> By: If you can manage risk, don’t you deserve a better return? « How to Make 7 Million in 7 Years™ http://7million7years.com/2008/12/19/the-allure-of-diversification/comment-page-1/#comment-2112 If you can manage risk, don’t you deserve a better return? « How to Make 7 Million in 7 Years™ Mon, 02 Feb 2009 03:10:46 +0000 http://7million7years.wordpress.com/?p=886#comment-2112 [...] risk, don’t you deserve a better return? Published February 5, 2008 Rich Diversification is an example of a risk management tool … I take exception with it because the financial [...] [...] risk, don’t you deserve a better return? Published February 5, 2008 Rich Diversification is an example of a risk management tool … I take exception with it because the financial [...]

]]> By: Adrian http://7million7years.com/2008/12/19/the-allure-of-diversification/comment-page-1/#comment-2111 Adrian Fri, 02 Jan 2009 23:25:20 +0000 http://7million7years.wordpress.com/?p=886#comment-2111 @ Rick - Thanks for your comments and Happy Holidays to you, too! BTW: I don't hold 'special expertise' in stocks, yet I only suffered a 15% loss in my total US stock holdings, which were 100% financed ... doesn't sound like a great outcome, but the market dropped 45%+ over the same time period and money saved is money earned. In short, we disagree :) @ Rick – Thanks for your comments and Happy Holidays to you, too!

BTW: I don’t hold ‘special expertise’ in stocks, yet I only suffered a 15% loss in my total US stock holdings, which were 100% financed … doesn’t sound like a great outcome, but the market dropped 45%+ over the same time period and money saved is money earned. In short, we disagree :)

]]> By: Rick Francis http://7million7years.com/2008/12/19/the-allure-of-diversification/comment-page-1/#comment-2110 Rick Francis Fri, 02 Jan 2009 17:39:33 +0000 http://7million7years.wordpress.com/?p=886#comment-2110 Adrian, I have to respond to this one even though it's pretty late - BTW happy Holidays! #1 Spreading too thinly- I agree that no one can be an expert in all areas. However, is being an expert worth the effort? I can accept market average returns with virtually no effort: for the sake of argument let us assume for stocks 10% over a 30 year period. Sadly, most professional mutual fund managers don’t beat the market averages, so not only do you need to have special expertise but you need exceptional talent, skill, or luck too! Warren Buffett has a 20% long term record, but he (and a lot of others) works full time to get those returns. Assuming I can develop the special expertise to be as good as Warren I still would need more than $1M of capital for the additional returns to cover the cost of a salary for myself. Unless I’m getting paid by an employer or I have a few million to invest the additional specialization doesn’t pay off! I don’t know the numbers for real estate, but it seems likely that a similar argument would hold for any type of market. Most traders (including professionals) would fail to beat the market average although some exceptional traders can do so by exerting full time effort to maintain their skills. I suspect that specialization only pays off with an area you have talent and devote most of your time on. The best you can reasonably expect in the long term for any truly passive investment is market average returns. If you have a special talent for picking stocks or real estate, or doing anything else then that probably should be your primary employment. Here is the real problem- how do I know if I have a real talent for trading? To really know you would need to track your returns for years as random selections or a particular strategy can beat the market averages in the short term, but may loses in the long term! #2 Chasing returns causes most people to underperform the averages in the stock market. Today’s best investment may well be tomorrow’s disaster. Concentration is risky, if you win great but if you lose you lose big too. I suspect the Enron employees that had all of their retirement savings in company stock don’t have a good feeling about concentration. Diversification reduces risk at the cost of lower returns, but I would argue most people are better off with the lower risk then trying to pick one super stock. I’ve tried to beat the market in the past and I even succeeded for a while, but over the long run I’m no longer convinced that I can reliably do so because of the very convincing arguments in A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing. -Rick Francis Adrian,

I have to respond to this one even though it’s pretty late – BTW happy Holidays!

#1 Spreading too thinly- I agree that no one can be an expert in all areas. However, is being an expert worth the effort? I can accept market average returns with virtually no effort: for the sake of argument let us assume for stocks 10% over a 30 year period. Sadly, most professional mutual fund managers don’t beat the market averages, so not only do you need to have special expertise but you need exceptional talent, skill, or luck too! Warren Buffett has a 20% long term record, but he (and a lot of others) works full time to get those returns. Assuming I can develop the special expertise to be as good as Warren I still would need more than $1M of capital for the additional returns to cover the cost of a salary for myself. Unless I’m getting paid by an employer or I have a few million to invest the additional specialization doesn’t pay off!
I don’t know the numbers for real estate, but it seems likely that a similar argument would hold for any type of market. Most traders (including professionals) would fail to beat the market average although some exceptional traders can do so by exerting full time effort to maintain their skills.
I suspect that specialization only pays off with an area you have talent and devote most of your time on. The best you can reasonably expect in the long term for any truly passive investment is market average returns. If you have a special talent for picking stocks or real estate, or doing anything else then that probably should be your primary employment. Here is the real problem- how do I know if I have a real talent for trading? To really know you would need to track your returns for years as random selections or a particular strategy can beat the market averages in the short term, but may loses in the long term!

#2 Chasing returns causes most people to underperform the averages in the stock market. Today’s best investment may well be tomorrow’s disaster. Concentration is risky, if you win great but if you lose you lose big too. I suspect the Enron employees that had all of their retirement savings in company stock don’t have a good feeling about concentration. Diversification reduces risk at the cost of lower returns, but I would argue most people are better off with the lower risk then trying to pick one super stock. I’ve tried to beat the market in the past and I even succeeded for a while, but over the long run I’m no longer convinced that I can reliably do so because of the very convincing arguments in A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing.

-Rick Francis

]]> By: Josh http://7million7years.com/2008/12/19/the-allure-of-diversification/comment-page-1/#comment-2108 Josh Sat, 20 Dec 2008 19:56:59 +0000 http://7million7years.wordpress.com/?p=886#comment-2108 I agree Andee, what you commented sounds like the Warren Buffet quote "Risk comes from not knowing what you're doing." I agree Andee, what you commented sounds like the Warren Buffet quote “Risk comes from not knowing what you’re doing.”

]]> By: Andee Sellman, One Sherpa http://7million7years.com/2008/12/19/the-allure-of-diversification/comment-page-1/#comment-2107 Andee Sellman, One Sherpa Sat, 20 Dec 2008 08:59:29 +0000 http://7million7years.wordpress.com/?p=886#comment-2107 Hi Adrian, Thanks for another great post. On the question of diversification, do you think it has something to do with risk? I was thinking about the old phrase of Risk and Return. i.e. the higher the risk the greater the return. This has been used in the past to steer people away from high return. How about taking the opposite view which is; If you can manage the risk better than anyone else then you deserve to get the high return. However, there's only a limited number of risks that you can manage well and this often leads to LESS diversification and sticking to your knitting. One of our clients said to me that he knew everything that could go wrong in his business and therefore wanted to pull money out and diversify. My question of him was this: Why would you take money out of something where you know the risk and can manage it and put the money into something different where you don't understand the risk and therefore can't manage it!! Hi Adrian,
Thanks for another great post. On the question of diversification, do you think it has something to do with risk?
I was thinking about the old phrase of Risk and Return. i.e. the higher the risk the greater the return. This has been used in the past to steer people away from high return. How about taking the opposite view which is; If you can manage the risk better than anyone else then you deserve to get the high return.
However, there’s only a limited number of risks that you can manage well and this often leads to LESS diversification and sticking to your knitting.
One of our clients said to me that he knew everything that could go wrong in his business and therefore wanted to pull money out and diversify. My question of him was this: Why would you take money out of something where you know the risk and can manage it and put the money into something different where you don’t understand the risk and therefore can’t manage it!!

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