Diversification — An argument against
Diversifying your investments has pros and cons. It’s fairly clear, most everyone understands the pros, and why you do it. Most financial planners will generally say… diversify, diversify, diversify, but generally speaking, they’re not rich, because wide diversification usually doesn’t make people rich. If you want to get rich, take the advice from rich people.
More often than not, most rich people generally made their money through a very concentrated ownership of a few things at most, and they would double down on what worked. This is true for both investors, and entrepreneurs, as entrepreneurs create their own stock, make it valuable, and then sell it to the public. They. in many ways, like a hyper-focused investor, have their portfolio high concentrated into one stock or two, generally their own.
Warren Buffet and Peter Thiel, both extraordinary investors, couldn’t be further away from the types of companies they invest in.
Buffet, likes to invest into companies, that he can see won’t change in 20+ years from now. Corporations that are cashflow positive, lower risk, generally not technology and investing into great companies, at a good price.
Thiel on the other hand, invests in starts up, likely to change dramatically in the future, generally with no positive cashflow, very high risk, and at sometimes, at extreme expensive & high valuations.
Although as different as they are, there is one thing they both agree on, neither of them like diversification.
“Diversification is protection against ignorance. It makes little sense if you know what you are doing.” — Warren Buffet
Although Berkshire Hathaway, Buffet’s company, owns a variety of different companies today, there is a general, concentrated theme among them. A lot of similar businesses, and industries. Warren would rather do extensive research and ensure he’s investing into the right company, for a long period of time, when the time is right vs. simply diversifying for diversification sake. What’s lost in diversification, they make up in experience, and doing extensive due diligence when purchasing a company. Buffet likes to put “meaningful amounts of money, into a few things.” Him and his partner Charlie Munger, think investing should be like marriage, for life. When they have cash on hand, and the time is right, instead of looking at other companies, they will just continue to buy more stock in the same companies they own, until they own it all. Why continue to look at others, when yours are already doing so well, and you believe they’ll be well in 20+ years from now? They just continue to concentrate into what they have, because they know it’s good. And they will wait, until the company they love, becomes discounted again, and they’ll buy more of it.
“I think that people would say that they spray and pray because of some sort of portfolio theory, some sort of diversification theory. And if that’s true that might work. I don’t actually believe that to be true. I think the real reason people spray and pray in their investing, is that they’re lacking in any conviction, and perhaps because they’re too lazy to really spend the time to try to figure out which companies what companies are ultimately going to work.” — Peter Thiel
Peter believes wide diversification, is like treating you’re investing like the lottery. As once you start to believe there is a small probability of a big pay off, then you’re thinking in lottery terms, and not thinking clearly, or at all. Like the lottery, you’re likely to lose money and have below average results. He, like Warren, believes it is best to really know the company, the founders, the mission, and really understand and believe if they’re going to be the absolute best in the future or not.
And like Warren to a degree, he is investing for a long period of time. It takes a significant amount of time before VCs get the money back. They aren’t traders, they are investors.
Someone I knew closely, shared with me, their super diversified portfolio. They had bought everything 10–30 years ago. Because they did not know what to buy, they diversified, and bought every type of financial service they could think of. Varying from individual stocks, some domestic, some foreign, mutual funds, a lot of different ones, many types of life insurance products, all types of IRAs, traditional retirement accounts, roth accounts/, and real estate, in several cities, some owned outright, and others as tenants in common, ran by others. They figured, why not try them all, and hopefully that’ll work.
Now this isn’t bad. It’s much better than doing nothing. In fact it’s great. But if you want to get rich, you’re going to need to do more on top of it. And if one is working well, then learn and readjust it. After reviewing them all with them, it was clear there were really only a few winners over the last 30 years. The winners were dramatically better than the others. We helped them rebalance their portfolio and refocus on what worked so well. Today, they are much much better off. The banks don’t understand why we’re not more diversified these days, but we do, we have a few asset classes we love, that work well, and we continue to just reinvest into what works best for us.
In my own world, I used to be an active tech entrepreneur. Instead of buying things like the index funds, which are super diversified, I’ve always choose to invest into my core competencies. Investing into companies I knew and believed where the best in the spaces I worked in. Many of the tech companies I’d invest in, I was a customer of, and I knew without a doubt they were way better than the others. So I invested my money into the same companies that I spent money with. Due to having experience in this, I choose very well. I did my research, I understood the companies, their business model, I knew it worked for me and others, and I monitored their financials on a quarterly basis to make sure they still have room to grow. Had I just chosen index funds, or even worse, mutual funds like everyone else, my portfolio would have suffered.
If you want to really grow your portfolio, you will likely need to be a lot more active, than the regular passive investors. Those who see to get normal returns, can invest into normal things, and diversify like normal people. While being active, doesn’t mean you’ll find one what works well, it does mean that you will monitor it, think, learn, evaluate, and adjust as time progresses on what’s working and what’s not. Most people, setup their portfolios and never look at them again, or even worse have others manage it from them. It’s important to understand what you want, and as you gain more practice investing, winning and loses, you’ll get clearer on what works best for you. If you’re good, you’ll start to realize a few patterns, and focus your investments on what’s working well, and really make it work. Diversification is not bad, but it does not produce huge returns.
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PS: My goal is to create a simple investment book by the end of the year which I’ll share with everyone. If you would like updates on new blog posts, and the release of it. Please give me your email here, and I’ll add you to my list.
-Wes
