Sunday, May 07, 2006

The dual-edged sword to "Diversify, Diversify, Diversify"

I had been told by numerous financial advisors during my financial infancy to "diversify, diversify, diversify."

Diversification is a tool for preserving wealth, or growing assets slowly and conservatively, but not for building great wealth. If you consider the list of richest people in the world, most did not attain their financial status through diversification.

It is also in the interest of brokers to advise diversification, because it provides them an earnings stream for transferring your current holdings into other assets.

Being a fiscal conservative, I started diversifying my assets when my net worth reached $1.6 million. Had I not ever diversified, I would be worth north of $40 million today (before taxes). But had things turned against me, I could also have gone broke - I saw this happen to some of our competitors. So know what you're doing before you diversify!

My advice is to develop your own financial intelligence. I definitely know a lot more know than I did 5 yrs ago. I have worked with many brokers over the course of the years at many institutions. In many cases, I now trust my own judgment vs a financial planner's or advisor's advice. Financial intelligence also allows you to filter through the multitude of advice you receive.

In the old boom days of the stock market 1999-2000, the brokers were useful mostly for getting access to IPO stock at pre-IPO prices, and the deck was heavily stacked against retail investors. Brokers would offer their top clients shares at pre-IPO prices and flip them within a few hours of the start of trading, for sometimes obscene gains, all at virtually no risk to the client. Since those wild IPO days are gone, the full-service brokers have lost a big reason for using them.

I have also learned that you need look into your holdings in more detail before you consider yourself diversified. Many funds have similar holdings. Even if you are invested in small-cap, mid-cap, large-cap, and international funds, this may not prove to be adequate diversification. During the 2000-2002 mini-recession, foreign (European) stocks were sold off just as heavily as US stocks. The world economy is so co-dependent now, that a recession in the US would trigger a world-wide recession, because much of world-wide spending is driven by the US.


FR said...


Thanks for dropping by at my website and leaving the comment. May I ask what nationality you are? I am wondering if you might be interested in being considered for the AApfblog (if we decide to launch it).

Could you tell your financial background story soon? I am interested in knowing how you've reached your net worth. It is truly admirable (esp. after what you've written on my blog)! said...

In response to your post and your latest comment on my blog:

I think your decision of diversifying 25% out of your company is a wise one, although in retrospect, it is very costly. Hindsight is always 20/20, and if I know with 100% probability that market will go up or down in the next hour, I can easily make hundreds of millions from that certainty through leveraging (assuming that I can find people to lend me money). Who would have thought that your company stock will go up by 20X from IPO? If I were you, I would have sold everything before 20X was reached.
I admire what you have achieved. Looks like your networth is in the units of $10M, if not more than $100M. I don't think I will reach that in this lifetime. To reach such height, I always think it takes a minimum of some luck. But of course, the tremendous amount of hard work is always a NECESSARY condition for such thing to happen. Congratulation on the pay-off from all of your hard work.

Yeah, diversification is the game for average people. I have yet to write a post on this. Only the intelligent people with daring conviction will focus their effort, money, and resources somewhat to generate out-sized return. It's hard to critique index investing & efficient market hypothesis while it is so popularly accepted. Once I have enough time, I will try my best to put up a post on my blog.

mOOm said...

Focusing on a highly productive idea makes a lot of sense but also putting some money into an alternative strategy is very prudent. And that alternative is likely to be diversified. Then you can take a big shock to the main strategy and still survive financially. For me at the moment my main strategy is my technical trading strategy, though so far I have less in that strategy as it is pretty new than I plan to eventually. But I would never put everything into one asset.

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