I Hate Diversification

Bill Parrott |

Warren Buffett described diversification as "diworsification." He is not a fan of it and prefers to concentrate his bets on a select group of companies. I can't argue with his strategy or success. Diversification means you must constantly apologize for something.

If diversification works correctly, some investments are up, and others are down; some outperform, others underperform. For example, the S&P 500 is up this year while long-term bonds are down. Last year, everything fell except for commodities. Most asset classes finished in positive territory in 2016, 2017, and 2019. If you own a basket of diversified funds, your portfolio will never match the best or worst-performing asset class. During COVID, the S&P 500 was up 18.29%, while real estate and commodities dropped 4.68% and 7.84%, respectively. However, a globally balanced portfolio was up 8.63%. Below is an investment quilt, and you can see assets fluctuate significantly. If you track the yellow cells for the S&P 500, you can see the variation in its annual performance.

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Long-term bonds are down this year, as they were last year and the year before, and they're producing their worst three-year performance ever. The consistent comment I hear from clients is, "Why do we own bonds?" I understand. It's frustrating to look at a losing position.

Conversely, no one has asked me why we own the S&P 500, which is up this year. During his review, one client asked why we can't put everything in Apple stock. Another client questioning his bond allocation said, "It feels like the apocalypse." And everybody wants to own the Magnificent Seven Stocks, which are up, on average, 76% this year - a no-brainer. However, in 2022, they were not magnificent. On average, the seven stalwarts were down 46%, and few people wanted to buy the lot. Hindsight is lovely.

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Despite my hatred for diversification, I've yet to find a better investment strategy, and I've tried many, like market timing, seasonal trading, value, growth, income, momentum, charting, etc. The list goes on and on, but the one tried-and-true strategy is owning a diversified portfolio of stocks, bonds, and cash and holding them forever because you never know when, where, why, or how markets will move. During the COVID correction, investors liquidated billions of dollars worth of stocks before the S&P 500 rocketed 63% from March 2020 to January 2021.

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A diversified portfolio gives you access to thousands of securities worldwide, including the Magnificent Seven. A well-constructed portfolio exposes you to several investments and asset classes, diversified by size, sector, type, and location.

The classic diversified model is the  60/40 portfolio – 60% stocks and 40% bonds. It struggled last year, like everything else, but it has rebounded nicely since last October. Vanguard's Balance Fund tracks the 60/40 model; since 1992, it's up 923%, averaging 7.79% annually. A $10,000 investment is now worth more than $102,000.

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Times are dark and difficult, with wars raging in Israel and Ukraine, rising interest rates, and political unrest, so investing your money in a US T-Bill to ride out the storm makes sense. A guaranteed 5% rate sounds good. T-bills are safe and have never lost money, averaging about 3% annually from 1926. A $1 investment in 1926 is now worth $22 – no risk, no reward. We are experiencing another challenging investment environment, but that's an ideal time to buy, and the best way to invest your money is through a diversified portfolio of low-cost funds.

Don't gamble; take all your savings and buy some good stock and hold it till it goes up, then sell it. If it don't go up, don't buy it. ~ Will Rogers


October 26, 2023

Bill Parrott, CFP®, is the President and CEO of Parrott Wealth Management in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level.

Note: Investments are not guaranteed and do involve risk. Your returns may differ from those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren't suitable for every investor. Prices and yields are for today only and are subject to change without notice. Past performance is not a guarantee of future performance.