Diversification or Dilution
I’m a believer in Diversification as a component of any long term investment strategy. One of the most famous money managers of all time, Peter Lynch, once said “I love all my stocks–that’s why I own them–but I know 20% are going to be dogs and disappoint me. I just don’t know which 20%”.
This is a key investment strategy.
This week’s video I talk about Diversification and Dilution. Are you truly diversified?
Good morning, Mike Brady Generosity Wealth Management talking to you from Boulder, Colorado. And today I want to talk about diversification, dilution, how much diversification is good, how much is a waste, just kind of what my thoughts are around that. Because every once and awhile I’m asked the question, “Mike, how much is you know really diluting the returns? And I’ve heard that so many sectors, or stocks or mutual funds or something, it’s just really waters everything down and you don’t get ahead…”
You know I’ve heard that before and my answer to that; and by the way I only hear that when the market is going up, but I never hear it when the market goes down. I mean people like being diversified when the markets are going down because chances are, I’m generalizing here, that the decline is not as much as if you were in one individual stock or one individual sector. And so really you have to look at both…, the market does three things; up, down, sideways- that’s it. There’s no rocket science around that. It goes up, down or sideways. And yeah, in an upward market you wish, that in hindsight, you were in this particular hot stock or this particular hot sector. But unfortunately, that’s hindsight and you have to acknowledge that we don’t know what the future holds. But what we are doing is an analysis of what we think might be in the future and weight things accordingly. Understanding that, “well, gosh, I might be wrong.”
And so, diversification: I’m not an individual stock picker. I’ve never recommended an individual stock to a client in my entire 21 years because I’m of the belief that I want to decide on a sector. And a sector in my mind is not necessarily biotechnology or something very specific, although that is also a sector, but what I’m talking about right here is large cap, small cap, middle cap, mid cap, value or growth, US, international. These are the types of sectors that I’m looking at. And it can also be sub-sectors that I mentioned earlier like biotechnology or health care or automotive or consumer discretionary etc. But either way, it’s really through analysis of what you feel that sector is looking at because when we go a layer deeper to the individual stocks there can be four out of five companies, let’s say, that are doing well in that sector and one that is not, and are you going to be good enough to choose (not choose in this case) that one that has done really poorly? I think that is a very difficult thing to do and so it’s one of the reasons that I believe that sector, or even which kind of category of stock or bond, depending on the client, is the better place to be.
From a diversification point of view, most studies have shown that once you get over 20 you’re not getting increased value for having that 21st stock or if you have 40 you’re not twice as diversified as if you just have 20. That’s what many studies have shown. My experience, and kind of my approach, is once I choose a kind of a broad sector, whether it’s large cap, small cap, mid cap, etc., I usually have one to two positions within there; a lot of times an index within those particular sectors. And the index itself is of course, usually dozens if not hundreds of stocks. But I’m buying the particular sector or that particular category, whether it’s growth or value or large or small, etc.
So I don’t believe that, I mean, dilution is really only when somebody wants to start hitting some home runs. I think that diversification is a better approach and the three types of markets that I’ve described, up, down and sideways, I do believe more in a kind of sector approach to it. If you haven’t already gotten that from this video, for goodness sakes.
So how much is too much? How much is too little? There’s no right answer to that. It is something that I talk about with each client and I’d love to talk with you as well. 303.747.6455, Mike Brady. I’ve got a couple of disclosures here coming up so stay tuned for that and you have a wonderful week. We’ll talk to you later, bye bye!