Should your self-directed retirement account be “well-diversified” as is the popular advice today? My opinion is 180 degrees opposite conventional wisdom… and the greatest investor in history agrees with me. My name is Bryan Ellis. This is episode #282 of Self-Directed Investor Talk.
Hello, Self-Directed Investor Nation, welcome to another high-energy, ever-exciting, booming in popularity edition of Self-Directed Investor Talk, the show of record for savvy self-directed investors all across the fruited plane! I’m glad to have you with me for today’s episode, another example of contrarian brilliance, as you’ll soon see.
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But today, we move on to a more fundamental question, the question of whether you should be “diversified” in your self-directed IRA or solo 401(k). And well, my opinion, well… before I jump into that, I’ll invite you to participate in today’s show in whatever way gives you the warm fuzzies. You can reach out by telephone anytime, 24-7, by calling toll-free 833-SDI-TALK. You can drop us an email at feedback@SelfDirected.org. And you can visit today’s show page which is SelfDirected.org/diversification …
Ok. It’s hard to imagine it’s necessary to begin with a description of the concept of diversification, as it’s been so aggressively shoved down our throats from Wall Street types that it’s broadly accepted as the gospel truth without analysis or dissent.
Well, folks, I tend towards believing that ideas supported as unassailable truth but that are supported with statistics alone but not with exception-free mathematical and/or scientific proof are inherently worthy of criticism, dissent and analysis. Dissent doesn’t mean the idea facing dissent is wrong. Dissent is another opportunity to demonstrate the truth of the… well, truth. Similarly, ideas that are very, very popular aren’t inherently correct. That’s more true now than ever before, I suspect.
And thus we arrive at diversification, that financial strategy that says “don’t put all your eggs in one basket”. Wall Street tells us to have a “well-diversified portfolio of stocks, bonds and mutual funds” and to “change your allocation to match your life circumstances”.
Look… there’s a grain of truth to this. But only a grain. And unless we’re talking about a grain of a mustard seed of faith, a grain doesn’t really count for much.
The grain of truth is that yes, your investments should match your station in life. For example, in your youth, liquidity in retirement investments isn’t particularly important. But as you reach and firmly enter retirement years, liquidity really matters. That is a practical, unimpeachable reality.
But the rest of it? Please. First of all, owning many different types of stocks, bonds and mutual funds is hardly diversification at all. That’s little more than owning different types of the same asset class. Is that really diversification? No, it’s not.
See here’s the thing: Diversification is NOT an investment strategy, it’s a hedging strategy. Hedging is designed to prevent loss, not to create gains.
That’s not a bad thing. The job of every self-directed investor is first to protect, then to grow, their capital.
But do you think that diversification is so popular because it’s the BEST strategy? No, no, no my friends… it’s so popular because it’s the most legally prudent strategy for Wall Street and for conventional financial professionals.
Why? Well, again, hedging is designed to prevent loss, not to maximize gains. There’s certainly a place for that, but diversification accomplishes that by essentially guaranteeing that mediocrity is both the lower AND upper limit of your results.
Diversification is the way that your hot shot financial advisor or broker can avoid culpability in the event that things go south in your portfolio. After all, if you’re invested in only one stock and that stock tanks, it would be easy to blame that on the person who advised you to buy that stock. But if you own 100 stocks and most or all of them tank, resulting in just as much loss as if one stock took a dive… well… that’s clearly a macro economic event beyond anybody’s control…
…and that’s exactly why diversification is the default strategy of Wall Street for individual investors.
Curiously, though, not everybody accepts diversification as an unassailable truth. I don’t, for one. And the most successful investor of all times doesn’t either.
His name is Warren Buffet. Maybe you’ve heard of him.
Buffett once made this comment: “Diversification is protection against ignorance. It makes little sense if you know what you’re doing.”
Hmmm…. The concept of knowing what you’re doing… hmmm. Interesting. So it seems there’s a dichotomy here. If you know what you’re doing, you focus your investments. If you’re ignorant, then you diversify.
Don’t shoot the messenger. It’s Buffett’s quote, not mine. I merely whole-heartedly agree with it.
Buffett has really lived by that philosophy, too. Unlike most investors, he hasn’t tended towards buying pieces of companies as much as he’s tended towards buying ENTIRE companies, or at the very least, very large pieces of them. Diversification is not a hallmark of the Berkshire Hathaway approach.
So what about you? Do you know what you’re doing, or are you ignorant? That’s really the question, isn’t it?
So here’s an example decision:
You have a self-directed retirement account. There are two opportunities in front of you. First is to buy into a publicly-traded REIT that owns a bunch of apartments across the country. The share price is, as is generally the case with REIT’s, quite volatile but it usually pays around 10% per year in cash flow. And this REIT owns dozens of multifamily properties across the country, which encompasses thousands of doors of rental income. That’s the definition of diversified.
On the other hand, you have found an individual property that’s pretty standard in every way. It is in a slow-growing, 3%-per-year type of location. The cash flow yield tends to be around 6%. There’s nothing particularly astounding or unusual about this. But here’s the thing… you’re able to get this property for only $70,000 rather than it’s actual value of $100,000.
Think about it. That discount gives you a tremendous amount of both leverage and safety. Leverage and safety… together, at the same time. What a concept! Leverage and safety TOGETHER.
That could be accomplished in a different way, too… such as if the price was closer to retail, but you had some reason to bank on much higher-than-normal cash flow.
Either way, this idea of high leverage and safety at the same time is the essence of value. Investing should always and forever be about VALUE, not diversification. When your investments are based on VALUE, diversification becomes a fool’s game.
So is diversification a bad idea? According to Buffett, it’s not a bad idea at all if you’re ignorant. But if you’re not… if you take the time and make the effort to only invest your money where there’s REAL VALUE in an objective, mathematical sense – not just in a “gut feeling” sort of way – then diversification becomes counterproductive… even dangerous.
So the question for you: Are you ignorant, or are you taking the time to truly respect your capital by seeking out truly excellent value propositions. That’s the deciding factor for whether diversification is the right model for your retirement portfolio.
My friends… invest wisely today, and live well forever.
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