A Dangerous "Diversification"?

Amen of the Week:

Twelve years ago I attended a dinner meeting where Warren Buffett spoke to investors. He said something that still resonates with me today -- especially on days like we've seen this past week:

“The way people have built fortunes has been by analyzing what businesses will look like in three to five years, not by forecasting short-term stock prices.”

- Warren Buffett

Do you really know what you own and why you own it?

Chances are your adviser has your money “asset allocated” among a dozen or more ETF’s or mutual funds, through which you may own over 500 individual stocks collectively. Basically, you own the market. This “own-a-bit-of-everything” approach has worked well the past three decades, as securities markets have broadly risen. Realize, however, that one driver of these returns has been the steady decline in interest rates.

Finance 101 teaches that as interest rates fall, financial assets (stocks and bonds) inflate. In recent years, interest rates have been artificially depressed, and so one could conclude that stock and bond prices are artificially inflated. If all markets have been similarly affected, it begs the question whether the “market portfolio” is true diversification. A school of fish might have a thousand fish, but it moves as one school. Likewise, if you own a thousand securities, you really own one thing: a market basket of financial assets.

Should your life’s savings be riding on a market bet? Maybe it’s time to stop driving with the rear-view mirror and take a more forward-looking, focused approach. Should we talk?

Yours in the Field,

Frank Byrd, CFA

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