There is an urban legend that a brokerage once found that its best-performing accounts belonged to clients who were dead so could not meddle.1 Financial planners often rely on the theoretical performance of different strategies because actual investors keep putting in money, changing strategies, and taking out money. Skeptics often warn that in practice there are various costs and delays which make the same strategy work differently in real life. Sometimes you take out money to fix your roof just before the market crashes, or put in your whole tax refund just before it booms, or the country with the big investment returns also has big taxes on foreign investors. It occurs to me that I have an account which has followed the same strategy with no new money or withdrawals since 2014.
(This is another post outside the main topic of this blog! If you just want to read about books and swords, my article on ancient spears just appeared with Marine Corps University Press and is open-access!)
This small business in downtown Victoria has diversified to selling pizza and wine. But that would not protect it if a tsunami washes away the city or the next government decides that anyone who owns an ethnic restaurant is un-Canadian and should have their business confiscated and sold at auction
(The following is outside my usual topics but its an area of my expertise that I have not found anyone else talking about).
Wise investors use diversification to reduce risk. Any one investment might fail for many different reasons, but many different investments are unlikely to fail together. Additionally, what causes one investment to do poorly often causes others to do well. Rising energy prices hurt manufacturing (which buys energy) but not energy companies (which sell it). Rising wages hurt employers with many low-wage employers, but benefit businesses who sell to consumers. Classically, bonds and stocks tend to move in opposite directions under a given type of pressure, so almost all long-term investors will benefit from holding some of both. For most of history opportunities for diversification were limited, and a prudent investor might buy several plots of land, invest in a ship’s cargo, and make some loans to neighbours. In the 20th century, mutual funds allowed small investors to own dozens of different assets for low but significant costs. Today anyone with a bank account in Canada can buy an index fund that holds thousands of different assets around the world for around 0.25% of their investments per year. However, most of these funds lack one important type of diversification.
