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Diversification is key

It’s something that might explain why some superannuants were whinging about their fund’s performance a few years ago. It’s something that all financial planners should work by and it’s something that Warren Buffet once said was for wimps, but he is wrong.
It, of course, is diversification and it explains why most of the nation’s super funds have done so ‘well’ in the most disastrous stock market in most of our lifetimes.
Another bad quarter at the office for super funds were greeted by misleading headlines such as “Super funds gutted” after SuperRatings revealed the median balanced super fund had dropped 3.4 per cent in the three months ending September.
This took the typical fund’s return for the year used by 4 out of 5 workers in the country to negative 11.6 per cent.
The best performers, according to SuperRatings’ Jeff Bresnahan dropped only 6.6 per cent while the worst came in with 20.9 per cent.
Even more laudable was the fact that the median fund in the much more riskier category for growth funds recorded a 16.4 per cent loss for the year.
At the same time if someone had a portfolio exclusively of shares, which were a good representation of the ASX 200, then they would have seen the index fall from 6,563 to 4,600. That’s a 30 per cent slide.
And that’s why super funds didn’t look as flashy as the stock market recorded four years of over 20 per cent growth per annum. History shows it was too good to be true.
At the same time the best super funds recorded results close to 12 per cent, but the median fund was closer to 8 per cent and some super members complained when they looked at the stock market’s results. It undoubtedly encouraged some people to venture into self-managed super funds and if they did it without diversification they might be a bit cranky today.
By the way, diversification can have its challenges too with property trusts changing in character in recent years. The bitter experience of Centro and GPT shows that these assets now behave more like shares than what we used to think were property trusts.
In the 1987 Crash there was a so-called flight to quality which helped property prices, but right now we’re copping a double whammy of both share and property prices heading south.
Michael Dawson writing on SeekingAlpha.com thinks a lot of investors “di-worse-si-fy their portfolios by adding stocks in unfamiliar sectors for the sake of diversification.”
He says an academic analysis of Buffett’s trades over 25 years showed the Oracle of Omaha’s top 5 holdings, on average, have comprised 73 per cent of his portfolio. By the way, the boffins pointed out that he held 33 stocks, which is big for normal investors but small for a multi-billion portfolio.
“My mantra has been concentrate to get rich – diversify to stay rich,” Dawson advised, but he is starting to waver. “I may need to reconsider the last part.”
Now that we have seen the first decent bounce since the market spun out locally on October 10, the question is, do you buy in as a diversified investor?
It is tempting to follow Dawson’s mantra and “get rich” over the next few years, as the market recovers, by selecting great value companies and not worrying about being diversified.
If you are a newcomer determined to build your portfolio over the next three years or so, and we might need that time to get over this financial meltdown and likely global-wide, then buying great companies at these great prices should be the first goal.
Buffett has made the point and it is worth remembering that it is better to buy a “great company at a fair price than a fair company at a great price”.
But as you collect these companies should diversification be a consideration?
It is interesting that Buffett’s mentor Benjamin Graham was a diversification supporter and advised about spreading the risks.
For professionals like Buffett, diversification might be less necessary as they know how to value a company, but most investors haven’t got a clue about valuing a business.
Given the difficulties of being a Buffett in your own mind, diversification is the steady way to build wealth. The smarties could go long individual companies and then sell at the right time and outperform many careful investors, but experts have copped a shellacking since November last year.
Back in May, 2007, Buffett gave some temporary bad advice, which if taken now over the next 5 to 10 years could prove very valuable.
The Reuters website recorded his advice after a Berkshire Hathaway shareholder meeting.
"A very low-cost index is going to beat a majority of the amateur-managed money or professionally-managed money," he said.

The likes of Vanguard’s index funds have had a rough year as the indexes have gone savagely south, but now might be time to get on board for the long-term. And these are not only diversified, they’re relatively cheap. 

Published on: Thursday, November 06, 2008

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