Isn't it stupid to just to have one job, one car, be a citizen of one country, have one house and one family. I mean really - one must diversify. What would you do if you lost any one of those?
No, it's not stupid to concentrate wealth. Problems only arise when you do it stupidly, like buying too big a house, being part of the wrong family, living in the wrong country or buying an unsafe car.
Diversification does not reduce risk but it cuts your returns in half. All correlations go to one in a crisis and you can't hedge the end of the world.
Note: To all downvoters - putting all your eggs in multiple baskets does not protect you from an asteroid impact any more than a person with all eggs in one basket.
People who think diversification makes them safe are frankly wrong.
> Isn't it stupid to just to have one job, one car,
Indeed people who own a job, a car or a house are well advised to have insurance. And insurance is a form of diversification.
For countries the analogy is flimsy, but if you live in a country that has had any of: wars, dictators, property confiscation or high rate of violent crime in the recent past (which describes most of the non-developed world, including emerging countries), it's a good idea to have a passport and a way to move elsewhere.
Then buy insurance - put out a costless collar if you are that worried.
If you want to diversify you need to actually buy reverse correlated assets. So go ahead - hedge with options, hedge with futures, hedge with shorting the indices.
But don't think buying disparate companies protects you - it doesn't.
There are degrees of protection. No protection is perfect, but you're a lot less likely to be totally wiped out with a diversified portfolio. 100% of my wealth is in company A, and it goes bankrupt, I have nothing. If I have it in two companies, unless they are perfectly interdependent, I lower my likelihood of being completely wiped out from 100% to <100%. Concentrating wealth in a single company increases the variance in your outcome, which is something most people consider bad in financial planning. It also requires active management, because even most temporarily successful companies do eventually go bankrupt.
This is basic personal finance. TBH, I'm really surprised your comments aren't all at the lightest shade of gray already.
I fully understand the arguments for diversification. Just like I fully understand CAPM, modern portfolio theory and the assumption that var=risk.
But it's all bullshit. Why are you investing in companies that have that risk? If you understand which companies return higher returns - why aren't you all in on them?
It's bloody hard to find good companies and when you do - why on earth would you diversify into their worse off counterparts? You need to have heavy concentration in great companies where you are perfectly fine having a 10 year hold on at the right price.
Either I'm misunderstanding your argument or you are missing a fundamental tenant of finance (and indeed, most things in life). Higher returns typically comes with higher risk. A brand new startup is high risk with high reward if it pays out. The same thing applies to financial investments in high risk companies.
People take risks because they want to try and beat the historical growth in their portfolio. By taking on that risk, they know that they may lose money instead of grow their money.
Diversifying allows them to adjust how much risk they want to take above the standard market growth.
"Great Companies" is such a bad guide star for investing. Sears looked like a "great company" 10 years ago. Kodak? Any big box retailer?
Anyway, there are perfectly sound investing theories that say investing in the worst companies can result in higher returns than any "great company" investment portfolio. Value investing at it's most extreme. You just need a few of the losers to become mediocre to make huge gains, while trying to get great companies to grow past their high stock price is extremely hard.
I agree with your long-term strategy...but I don't see any reason to hold long-term stakes in individual companies. Why not just hold long term on index funds?
Risk and return are not correlated. There are risks and there are returns. See AAA bonds during GFC. Great businesses are great companies at reasonable prices not overvalued growth stocks.
Most of modern economic and finance theory is based on fundamentally broken models of risk and return.
Known risks and future returns are certainly correlated. Unknown risks (financial crisis meltdown) are obviously uncorrelated because they are unknown. You can't control for those, which is why you diversify.
What are you going to do when your "great company" has a horrible CEO scandal and sinks the company? That's an unknown risk that would be prevented by diversifying your investments.
Known risks (such as "can this company execute it's vision well enough to be profitable at 500m revenue/year?") are what you weigh against the return ("I personally think so, but the market doesn't, so I'm getting a discount on the stock price when it eventually succeeds").
Diversification reduces risk, it does not eliminate it.
Concentrating wealth in stock is a particularly dumb idea, because even public companies are relatively opaque. Enron looked like a pretty good deal to an outsider, right?
Using things like citizenship, cars, households and families is a straw man and not related to financial investment at all.
Enron didn't look like a good idea. They ran a commodity business at insane valuations with huge revenue run up during a bubble.
Stating that Enron was a good idea was like stating Groupon was a good idea. Commodity companies that buy revenue (includes WorldCom and MCI) are always bad investments. Once again - had you invested in them you would be a moron.
It'd be fair to state that diversification protects against stupidity.
However, it does not reduce risk in the way people assume.
Put it this way, from the outside they looked a lot better than they really were. Looking as bad as Groupon and actually going as sour as Enron did are two wildly different things.
Well here's my forward looking projection - Groupon, Zynga and Pandora will go bankrupt within the next 3 years.
It really isn't that bloody hard to see shit for what it was - if you aren't making any money, if you are buying revenue, and if your service is commodity then you will be both a bad investment and eventually go bankrupt. Enron, WorldCom, MCI, Zynga, Groupon, Pandora fit these cases and hence will fail.
It irritates me saying "Ohh who could've predicted the GFC, or Enron or WorldCom or the DotCom bubble or whatever". Just because you don't see the asteroid coming before it crashes - it does not follow that it was a black swan. Grab a telescope and you'd have seen it coming 30 years out.
If you aren't making money and your business model is neither defensible nor proprietary - you will go out of business.
Diversification only works if your assets are independent. Buying multiple stocks is the same as buying a call on the world - it only reduces localised risk.
But then again - why are you investing in companies that you believe have localised risk of bankruptcy and a low chance of attaining future profits.
Diversification does reduce the risk of losing it all, as it changes the probability distribution (https://en.wikipedia.org/wiki/Probability_distribution). It also reduces the probability of winning a lot, but people like stability.
No, it's not stupid to concentrate wealth. Problems only arise when you do it stupidly, like buying too big a house, being part of the wrong family, living in the wrong country or buying an unsafe car.
Diversification does not reduce risk but it cuts your returns in half. All correlations go to one in a crisis and you can't hedge the end of the world.
Note: To all downvoters - putting all your eggs in multiple baskets does not protect you from an asteroid impact any more than a person with all eggs in one basket.
People who think diversification makes them safe are frankly wrong.