Spreading investment risks

Q: Do you recommend spreading investment risks?

A: Both diversification and specialisation have a proper place and function for any who depends on an asset”s income stream or capital value. This doesn’t just apply to investors and speculators. What’s comfortable for one person may be inappropriate for another, but certain generalisations are worth considering.

Let’s start with a few fundamental economic facts. Man has economically advanced beyond a hunter-gatherer existence thanks to the division of labour and specialisation. Without specialisation and the division of labor it would take six months of work to produce a chicken sandwich. If you own a large number of shares in various market sectors, you’ll have no time to become an expert on all or many of your investments — likely you’ll have no time to become an expert on any one investment. This almost automatically guarantees a mediocre result, at best.

Banks and stockbrokers make money by selling securities to clients. If they offered investment advice to the same client they sell investments to they would have a conflict of interest. They generally do not give independent financial advice. This explains, in part, why the financial community extols the virtues of diversification. The client is taught to expect mediocrity. Beating the averages by five or ten percent is considered extraordinary. Banks and brokers benefit from low standards of expectation. You shouldn’t expect anything different from a party whose financial interests conflict with yours. Perhaps you should expect worse.

This doesn’t mean all diversification is bad. There is a time-honored diversification formula, which no main street broker or banker is likely to mention: one third in real estate, one third in liquid assets, cash and cash equivalents, and one third in your business, or, if not self-employed, in your area of specialisation. This is a solid base that provides the confidence to specialise.

Extraordinary profits require properly relating to economic law and understanding when you’re being exposed to propaganda. Economic law cannot be changed any more than the law of gravity, irrespective of how convincing the propaganda sounds.

by Arthur Fixed

[box type=”info” style=”rounded” border=”full”]Commentary from Arthur Fixed the author of the Art of Speculation during Civil War – Sun Tzu Meets Jesse Livermore is a private manuscript copyrighted 2012 by Art Fixed.[/box]

Photo credit: ERre1980 via Visualhunt / CC BY-NC-SA