Diversification & Concentration (Risk) in Investing

From Cathie Wood and Warren Buffet to the Holy Grail of Ray Dalio. What to expect when the music stops (for a minute).

Jan 24

Bonjour! 👋👋

First of all, welcome to the new subscribers who joined since last week!! On this week’s edition of Aconomics:

[1] Last week's numbers 🤢
[2] Diversification - A complex issue 🔥
[3] Cathie Wood: Down with the rest ↘️
[4] Congress beats the market 🚀

If you’re reading this but haven’t subscribed, do it! And If you like it and want to share it on social media, you have my blessing 😉

[1] Last week's numbers: Bye Bye Gains

I don’t know if there is much to add other than, it I’ll be ok. :) The market is destroying many obviously overvalued companies and as it happens in every correction, its doing a lot of collateral damage.

Remember the stock market typically declines:
10% every other year
30% every 4-5 years
50%+ once a generation

And every time, it recovers. Just look at this:

BUT, that’s the market in general, some stocks never so, so don’t expect to see RIVIAN back in 170 or ZOOM anywhere near 400. On the other hand, these corrections are the best moments high value stocks like Microsoft, Amazon and Google for example. As PE contract, this companies continue to grow at double digit rates with huge moats.

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But how can we minimize the pain of a downturn? And this brings us to section Numero 2.

[2] Diversification - A complex issue.

Well, in this section I’m going to mention Warren Buffet, Ray Dalio and Peter Lynch. These three have expressed their opinions on investing and many have misquote or misinterpret them, so lets clarify two important things first:

Nobody can time the market. Period. As simple as that.
99% would do better just buying an index fund and tracking the overall economy.

These are basic truths whether we like it or not, and these three legendary investors start from there.

Peter Lynch called it “Diworsification”, he makes the point that investing in a company is investing in a story that’s unfolding after checking many stories. If you found a good one, stay with one, BUT if you find 10 good ones, invest in those 10 and keep a close look on them to rebalance as you see them unfold.
Warren Buffett, usually after telling people to not invest in single stocks unless you do it professionally or do thorough research, tells his followers that diversification - and I’m paraphrasing here - “preserves wealth but concentrations builds it”.
Ray Dalio calls diversification “ The Holy Grail of Investing” and he brakes it down into 3 pieces: Risk, which he called the standard deviation, the number of assets or the sample size, and the correlation of the bets. - Long story short, he suggest that any portfolio finds 15-20 good uncorrelated return streams can reduce your risk of loosing money any given year by a factor of 4.

The bottom line is that, for best returns, its always better to concentrate your portfolio in very good companies (30 assets is the max according to most analysts) but its also the one with the most risk when a contraction comes around (ask Cathie Wood).

And diversification is the preferred way to preserve wealth, find uncorrelated assets and chill basically. But can we pivot between strategies? We know high PE stocks are going to have a bad time recovering but Energy and Financials stocks might do very well in a high inflation environment. We’ll see.

For now, we know that diversification in highly correlated assets might lead to disaster, lets look at Cathie Woods ARK Invest ETF:

[3] Cathie Wood: Down with the rest.

Somebody is not having a good start of the year, the most famous ETF of 2020 and start of 2021 has been killing its gains by the minute.

Look at how investing in ARKK or Berkshire Hathaway would have turned out from Q1 2020 to Today. And I would bet, Warren will win in 2022.

The only ARK ETF I liked, and still do, is ARKG but I had to part ways with Cathie around a month ago because I didn’t want to hold visionary profitless companies in 2022. Obviously I didn’t know that it would continue to go down as it has this month. So I was lucky!

But I decided to analyze ARKK and ARKW and make a video about it, so if you have a few minutes, here it is ;)

[4] Congress beats the market 🚀

I don’t know if this is funny or sad but, If you want to have crazy returns and beat the S&P consistently, there is one sure way of doing it:

Copy the members of congress!

And that’s it!

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