By DAVID MOON, Moon Capital
August 10, 2003
If there was a lesson investors learned from the collapse of the technology
bubble it was to diversify. Don't be too heavily invested in a single
area; that could be the one that blows up and wipes out your retirement nest
egg. You ought to own several investment styles. Growth, value,
small-cap. International. Extra terrestrial. Even better, you ought
to own several asset classes - just to spread your risk.
People learned the wrong lesson.
Diversification was not the lesson of the market collapse that began in
2000. The lesson was about value. The problem was that people bought
overpriced assets, not too few asset classes. Investors, particularly
institutions, use diversification as a replacement for knowledge about the
things they own. If you don't know much about the things you own, you
might as well own a little bit of everything. But diversification isn't a
good replacement for knowledge. It gives people a false sense of comfort
After watching their stock portfolios decline 30, 50 or 70 percent, many
investors became instant fans of diversification. Diversity, diversity,
diversity. Sell some stocks and move to bonds. Bonds were safe;
stocks were risky.
Can you say "sell low, buy high," boys and girls?
Selling stocks at five-year lows, these new disciples of diversification put
their money into supposed risk-free bonds. After all, what could go wrong
if you owned a Treasury bond?
Plenty. In the last two months, many bonds and bond funds declined more
than 15 percent. Rates are up, so prices are down.
Many investors now hold lower yielding bonds, the value of those bonds has
declined significantly and new bonds offer much more attractive yields.
But the worst part of the saga is that many of these investors sold stocks to
buy those bonds. They were diversifying. They thought they were
being smart. They were trying to avoid their mistakes of the late
All they did was repeat those mistakes.
The mistake investors made in the years leading up to the collapse of the
technology and large cap stock bubble wasn't a lack of diversification.
The two major mistakes were ignoring the underlying value of the investments and
having an inappropriate asset allocation. Folks had too much in stocks '
and the stocks they owned were overpriced.
An investor's asset allocation ' how much they have in stocks, bonds cash,
etc. ' ought to primarily be a function of personal factors. Things like
their risk tolerance and need for growth and income. Within each of those
asset classes, however, investors must focus on the value of the individual
securities (or mutual funds) they buy. Every asset is worth
something. When you ignore the value of an asset, it makes no difference
if you own 100 stocks or 50 mutual funds. Time is your enemy. You
are speculating. You are guessing.
Concentrating your money into only a handful of investments exposes you to
unneeded risk. Some diversification is wise. But Mae West was wrong;
too much of a good thing isn't always wonderful.
David Moon is president of Moon Capital Management, a
Knoxville-based investment management firm. This article
originally appeared in the News Sentinel (Knoxville, TN).