In the old fable The Tortoise and The Hare we find this classic tale of the slow and steady vs. the erratic and volatile. This fable lends itself well to many financial analogies, and rightfully so. Looking back at my personal investments over the years I am pleased with the prudent, tortoise-like decisions I’ve made yet I still experience some level of disappointment as I reflect on a few emotional, hare-like choices that I now regret. As an analogy for much of life, investing is a marathon, not a sprint.
In TOM this week, let’s examine the nuances of taking one’s time when investments are involved and how easy it can be to rush toward a fast buck.
Off we go….
Diversification – The Tortoise
Noble Prize winner Harry Markowitz the father of Modern Portfolio Theory famously declared, “When it comes to investing, the only free lunch is diversification.” I believe this statement is true and should be followed.
While I know Markowitz’ theory to be true, another “truth” about diversification is there will always be something in your portfolio that is disappointing you. In 2008 I would’ve loved to own all 10-year US treasury bonds and absolutely no stocks. In 2019 I would’ve had the opposite opinion.
Source: NYU Stern
Hindsight can lead us to some level of disappointment, and we must remind ourselves – slow and steady wins the race.
Concentration – The Hare
What is the opposite of diversification? Concentration. Although our Noble-Prize-winning friend may frown upon it, concentration has led to some people building extreme levels of wealth. Let’s take a look at the three richest men in the world according to Forbes:
What do they have in common? Each one of these individuals has achieved their billionaire status by placing a majority of their wealth into one company. Not to mention the countless other employees and investors who’ve accumulated millions of dollars in wealth, holding concentrated positions in these exact same companies. It’s truly phenomenal how these BIG bets have paid off.
It’s Been Said…
I’ve heard an old adage around the finance industry that goes something like this, “Concentration is a great way to become wealthy, diversification is a great way to stay wealthy.”
Let’s take a moment to dissect this. Yes, we all know the incredible stories associated with the Jeff Bezos and Bill Gates types of the world, but here’s reality, these stories are not the rule, they are the exception.
You want to know how hard it is to pick one single company, go all in, and be right? Well, how about this for starters, from 1989-2015 80% (that’s a majority) of all stocks collectively had a total return of 0%.
Source: Longboard Asset Management
You not only needed to be in the top 20%, but you needed to be in the top percentile of that 20% if you wanted to skyrocket your wealth.
And if you happen to find that winner, you also had to endure that erratic and volatile ride associated with owning a “hare.” Here’s what a 20-year concentrated position in Amazon looked like for Jeff Bezos (buckle up!):
Source: The Irrelevant Investor
Yes, that is multiple +50% drawdowns (negative changes in value), including a whopping 83% drawdown in 2000. To put that in perspective, a $1,000,000 investment at one point in 2000 was worth $170,000. An exercise not for the faint of heart.
We Know How It Ends
I started out today’s discussion talking about our friends The Tortoise and The Hare. For this particular fable, we know how it ends – The Tortoise wins the race. But could you imagine what it would’ve been like to be a spectator at that event? What were the Vegas odds on the Hare to win? Imagine watching the race at any of the particular checkpoints along the way. If you were a Tortoise fan, I am sure when he fell behind it was hard to believe that he’d cross that finish line first. It’s a reality, our perspectives during the race are much different than our attitudes once the outcomes have been decided.
This same truth applies to investing. Diversification is not exciting, but it is prudent; it’s annoying along the way but appreciated in the end.
We’ve referenced these Forbes billionaires who have taken this idea of concentration to its most extreme expression by owning just one company, but concentration can also surface in more subtle ways. Do your investments have a heavy concentration in one sector or industry? In one geography? In one particular type of risk? How sensitive is your portfolio to changes in interest rates? Oil prices? These are the type of questions you should ask, as this is prudent risk management.
As I said, these billionaire tales are the exception, not the rule. For every one of these stories, there are countless tragedies of folks sacrificing most (or sometimes all) of their wealth. Connect with your advisor today, review your portfolio, and look out for any looming risks that you maybe aren’t aware of.
Take the free lunch – diversify.
Until next time, this is TOM signing off…