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Taming the Beast: Wall Street's Imperfect Answers to Making Money by Larry Light

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Chapter 9

Spreading It Around: Asset Allocation

As a credo for living, it’s right up there with looking both ways before you cross the street and avoiding high places during lightning storms. One of the standard pieces of financial advice is that, for safety’s sake, your investments should be diversified—some in stocks, some in bonds, some in cash, maybe some in commodities or in real estate, and so on. The commonsense thinking here is that, if one component of your portfolio goes screaming down the chute, others will be okay, and you will fare fine overall.

What a shame that in 2008 and early 2009, almost everything except Treasury bonds took the express elevator to the basement. The gods seemed to be merrily mocking a central belief of investment planning. They weren’t alone. Critics of diversification have long said that scattering one’s assets across the financial landscape is a recipe for mediocre returns—better to plunk your chips in one place that is poised for greatness and get rich. (Assuming you can find this El Dorado, of course.)

Sometimes, concentration works. One key diversification tenet is that a fund should hold a large number of stocks, hundreds even. But there are almost 300 mutual funds containing only 40 stocks or fewer. A study from research firm Morningstar, covering 1992 to 2006, found these concentrated funds to be no more volatile than other funds, meaning they were no more risky. And a number of them have enviable records, such as Weitz Partners Value. ...

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