Warren Buffet once said that “diversification is protection against ignorance. It makes little sense if you know what you are doing.”
In other words, within the vast universe of stocks and bonds, why buy a grab bag of both winners and losers, if you can identify the winners and just pick those?
Mr. Buffet has built his legendary investing firm, Berkshire Hathaway, on the principle that, with enough research, you can find companies that are undervalued by the market and purchase their stock before it goes up. Of course, Berkshire Hathaway doesn’t just speculate in stocks, but often buys whole companies and then takes an active role in bringing them up to their potential.
But the problem with trying to copy the winners-only investment approach is that it requires you to “know what you are doing” every time. This is the hard part. And if you can’t do it on your own, it requires you to believe that somebody else could miraculously do it for you.
No One Can Pick Winners Every Time
Even with a formidable research department and some of the smartest people in investing making decisions, for the past several years Berkshire Hathaway has not been beating the market.
According to Business Insider, after peaking in 1985, when Buffet’s firm outperformed the S&P 500 by 35% on a trailing 10-year basis, their outperformance has steadily dwindled.
In the past nine years, they’ve underperformed the benchmark several times. And when asked by the Financial Times if Berkshire Hathaway would be a better investment than the S&P 500, Buffet said, “I think the financial result would be very close to the same.”
No doubt, at some future point, Buffet’s firm will again beat the overall market. It’s just that nobody knows when. And that uncertainty has been built into the price of their shares.
Diversification Is a Safer Bet
Diversification is simply admitting that you don’t know with any certainty what an individual stock, market sector, country, or even the market as a whole will do. So you invest with the widest possible variety of outcomes in mind. Maintaining the discipline of diversification is not as exciting as guessing right for a short-term payoff. After all, it means knowing in advance that you’re going to own some things that are not the top performers for some period of time.
Remember, there’s still “No Free Lunch.” Diversification doesn’t guarantee a future profit or protect entirely from short-term downturns in portfolio value. But if your long-term goal is a fully-funded retirement portfolio, diversification is your most prudent strategy.
As How Stuff Works says about diversification, “It might not be glamorous, but it’s a safe way to grow your money over a long period of time.”
Of course, all returns involve risk. But your trusted advisor can assist you with a plan that takes into account your unique circumstances, and help you stay the course when portions of your portfolio move in different directions.
This article is a service of the Quraishi Law Firm, Creative Business Lawyer®. We offer a complete spectrum of legal services for businesses and can help you make the wisest choices on how to deal with your business throughout life and in the event of your death. We also offer a LIFT Start-Up Session™ or a LIFT Audit for an ongoing business, which includes a review of all the legal, financial, and tax systems you need for your business. Call us at 870-275-4304, or schedule online today!