Krasimir Karamfilov of Pirgos Mirgos LLC shares his thoughts on diversification and successful investing.
In 1952, Harry Markowitz wrote an essay, entitled “Portfolio Selection".
In 1959, he wrote a book, entitled “Portfolio Selection: Efficient Diversification”.
In both writings, he laid out the diversification theory, which, Harry thought, helps to offset the uncertainty and risk of investing in the stock market.
In 1990, Harry won the Nobel Prize in Economics. He is considered the Father of Diversification.
Good for Harry.
Now, let’s continue with the definition of the verb diversify:
1. To make diverse: give variety to
2. To balance (as an investment portfolio) defensively by dividing funds among securities of different industries or of different classes
3. To increase the variety of the products of
As you can see, one of the definitions is related to money. That’s a good start.
What do they mean by “to balance an investment portfolio among different classes”?
In order to invest your money in different asset classes, you must know what asset classes are out there:
Stocks (equities)
Bonds (fixed-income)
Precious metals
Real estate
Cash and cash equivalents
There are many schools of thought as to what percentage of your saved money goes to each class.
In my experience, it all depends on your life situation. If you live lavishly, you probably need more cash.
If you are a penny pincher like me, you have little cash and more equities.
A well-balanced allocation of, say, $1,000, goes like this:
Stocks: $500 (50%)
Bonds: $250 (25%)
Real estate: $100 (10%)
Cash: $100 (10%)
Precious metals: $50 (5%)
Millions of people around the world diversify.
Millions of people have their money in 401(k) plans, which are diversified.
Millions of people retire, thinking that they increased their wealth in the last 30 years of work.
Here’s what I have to say to these people:
STOP THIS MADNESS!
Diversifying is like shooting yourself in the foot: You’re not dead, but you bleed money all the way to the grave.
WEALTH TRUTH #1: Nobody in the history of the world has ever become wealthy by diversifying.
To paraphrase: You will never be wealthy if you diversify.
Let me give you a couple of examples on why you shouldn’t diversify.
Had Bill Gates diversified, he would have sold half of his Microsoft shares and invested the money in… something.
Does he do that? No. Would he be the richest man on the planet if he diversified? No.
Does Warren Buffett diversify in bonds and gold? Of course not. He has 99% of his net worth invested in Berkshire Hathaway stock.
Why don’t the top two richest men in the world diversify?
WEALTH TRUTH #2: Concentration of capital builds wealth.
Therefore…
WEALTH TRUTH #3: Diversification of capital destroys wealth.
So, here’s my sage advice:
When you decide to invest in a particular asset class, invest ONLY in it.
In other words, don’t dabble in real estate, if most of your money is in bonds. Don’t buy gold, if you hoard your cash.
This way, you know where you’re headed. If you diversify, the volatile economy will kill your investing efforts.
Naturally, I am partial to investing in stocks. Nothing has beaten, beats, or will ever beat the investment returns from investing in stocks.
But we are all different. Who you are as a person will determine your investment strategy, risk tolerance, and profits.
We all work so one day we won’t have to work. The only way to succeed in this effort is to invest our money and get the biggest possible return.
Diversification is a guaranteed way to get lame returns. You can’t get more than 10% annual return with diversification.
Should that be your situation, I have news for you: You’re wasting your time. Here’s why:
- Inflation will eat up 3% of your profits
- Your rampant spending habits will take another 2%
- Life emergencies will use 1%
If you save $5,000 per year at 4%, after 30 years of work you’ll have $291,641.
With this much saved, you’re looking at 6 years of retirement. Then what?
Sadly, Harry Markowitz’s diversification theory was embraced by the masses. Warren Buffett’s trumpeting of the value investing theory was not.
I’m glad Warren did not listen to Harry. If he had listened, we all would have been much poorer for it.
________
By Krasimir Karamfilov, who is the manager of Pirgos Mirgos LLC, an investment company in Santa Monica, CA. He holds two Master's degrees in the arts, which helps him invest creatively.
In 1952, Harry Markowitz wrote an essay, entitled “Portfolio Selection".
In 1959, he wrote a book, entitled “Portfolio Selection: Efficient Diversification”.
In both writings, he laid out the diversification theory, which, Harry thought, helps to offset the uncertainty and risk of investing in the stock market.
In 1990, Harry won the Nobel Prize in Economics. He is considered the Father of Diversification.
Good for Harry.
Now, let’s continue with the definition of the verb diversify:
1. To make diverse: give variety to
2. To balance (as an investment portfolio) defensively by dividing funds among securities of different industries or of different classes
3. To increase the variety of the products of
As you can see, one of the definitions is related to money. That’s a good start.
What do they mean by “to balance an investment portfolio among different classes”?
In order to invest your money in different asset classes, you must know what asset classes are out there:
Stocks (equities)
Bonds (fixed-income)
Precious metals
Real estate
Cash and cash equivalents
There are many schools of thought as to what percentage of your saved money goes to each class.
In my experience, it all depends on your life situation. If you live lavishly, you probably need more cash.
If you are a penny pincher like me, you have little cash and more equities.
A well-balanced allocation of, say, $1,000, goes like this:
Stocks: $500 (50%)
Bonds: $250 (25%)
Real estate: $100 (10%)
Cash: $100 (10%)
Precious metals: $50 (5%)
Millions of people around the world diversify.
Millions of people have their money in 401(k) plans, which are diversified.
Millions of people retire, thinking that they increased their wealth in the last 30 years of work.
Here’s what I have to say to these people:
STOP THIS MADNESS!
Diversifying is like shooting yourself in the foot: You’re not dead, but you bleed money all the way to the grave.
WEALTH TRUTH #1: Nobody in the history of the world has ever become wealthy by diversifying.
To paraphrase: You will never be wealthy if you diversify.
Let me give you a couple of examples on why you shouldn’t diversify.
Had Bill Gates diversified, he would have sold half of his Microsoft shares and invested the money in… something.
Does he do that? No. Would he be the richest man on the planet if he diversified? No.
Does Warren Buffett diversify in bonds and gold? Of course not. He has 99% of his net worth invested in Berkshire Hathaway stock.
Why don’t the top two richest men in the world diversify?
WEALTH TRUTH #2: Concentration of capital builds wealth.
Therefore…
WEALTH TRUTH #3: Diversification of capital destroys wealth.
So, here’s my sage advice:
When you decide to invest in a particular asset class, invest ONLY in it.
In other words, don’t dabble in real estate, if most of your money is in bonds. Don’t buy gold, if you hoard your cash.
This way, you know where you’re headed. If you diversify, the volatile economy will kill your investing efforts.
Naturally, I am partial to investing in stocks. Nothing has beaten, beats, or will ever beat the investment returns from investing in stocks.
But we are all different. Who you are as a person will determine your investment strategy, risk tolerance, and profits.
We all work so one day we won’t have to work. The only way to succeed in this effort is to invest our money and get the biggest possible return.
Diversification is a guaranteed way to get lame returns. You can’t get more than 10% annual return with diversification.
Should that be your situation, I have news for you: You’re wasting your time. Here’s why:
- Inflation will eat up 3% of your profits
- Your rampant spending habits will take another 2%
- Life emergencies will use 1%
If you save $5,000 per year at 4%, after 30 years of work you’ll have $291,641.
With this much saved, you’re looking at 6 years of retirement. Then what?
Sadly, Harry Markowitz’s diversification theory was embraced by the masses. Warren Buffett’s trumpeting of the value investing theory was not.
I’m glad Warren did not listen to Harry. If he had listened, we all would have been much poorer for it.
________
By Krasimir Karamfilov, who is the manager of Pirgos Mirgos LLC, an investment company in Santa Monica, CA. He holds two Master's degrees in the arts, which helps him invest creatively.
