One of the defining moments of my current perception on personal finances, and market behavior in general, is when I first read something similar to the following:
- Wealth does not come from a diversified portfolio. Rather, true wealth is created by taking on concentrated risks.
The comment above was in the context of a more general sense that retail investors expect something from their investment portfolio that they shouldn’t–early retirement, living off dividends, buying a vacation home, etc. If you have enough money, a 5% return will accomplish all of those things for you and more. But for the vast majority of people, a 5% return will not support the lifestyle they would ultimately like to live. However, that statement also wasn’t referring to concentrating risks in a stock market portfolio; it was suggesting that wealth is created in outside industries through the creation of small business and the like.
Of course, you need to make good decisions–and possibly a little luck–when assuming those risks. Not only do you need a comprehensive understanding of the risks involved, but you also need to be certain that risk is mispriced. I like to think that wealth can be created through the stock market–I am not referring to running OPM or the IPO process, either; by concentrating capital where and/or when risk is mispriced.
I have a lot more to this line of thought, but it requires at least several thousand more words. So, I will leave you with this thought: If reward and risk have a direct relationship, but risk is composed of underlying factors as well as perception of those underlying factors*, is there not an opportunity to arbitrage the human error? I am, of course, assuming human error is rampant when it comes to perception and emotion.
I will explain how and why the perception of risk directly contributes to return the next time I post on this subject.
*For instance, a 1% GDP is perceived very differently now than it would have been in 2006.
13 Responses to Wealth is Not Created by a Diversified Portfolio
Very interesting subject. I will blog about this.
Agreed. The big wins are the 10 and 20 baggers that you can hold over multiple years – an AAPL or CMG for example. I owned both at different times. I became very conditioned to buying and selling when certain goals were hit – only to watch them go much higher when they didn’t pull back as I anticipated.
There’s a couple companies I’m watching now that may have that potential – but it’s a different market envirornment than it was when those two took off.
at least if “feels” different
Apple has at least another 10 fold return in it.
My view- Much of this is the mental process. A 10 bagger over the course of a few years, while the investor has a life doing other things, seems possible.
But for an active trader, even a double that happens quickly can be a (pleasant) conundrum. If I have an option position double overnight, I am compelled to sell, and move on. Of course sometimes it keeps moving up and I see the 5 bagger that could have been. Such is life, it is a learning experience.
I think with the time decay in options, “sell, and move on”, when presented with a large percentage gain, is a solid strategy.
I agree with the premise of the post…mostly.
I would argue that having an actively managed, diversified portfolio of dividend producing stocks is a key component to establishing long-term and sustainable wealth. However, I also think that should only a minority percentage (at least at first) of one’s assets.
Somewhere along the line, I do think that you do need a ‘break’. Usually that is attained through taking heightened risks. I’m not suggesting that someone needs to go “all in” or anything…but there are typically risks and resistance lurking behind anything worthwhile.
I would also agree that human error is prevalent in situations with heightened stress (i.e. losing money).
Thanks for the comments!
I will clarify my thoughts between creating and sustaining wealth in the future.
Nice, looking forward to it.
Who would you rather be, Derek Jeter or Jose Canseco?
… I am reminded of a William O’Neil quote …
“Diversification is a Hedge for Ignorance” !
William O’Neil is the Founder of Investors Business Daily !