One subject about which even professional investors hold widely divergent views is portfolio diversification. Most often, investors accumulate shares like postage stamps. While such diversity provides a feeling of safety and commemorates stock market history, portfolio performance is typically sub-par. Such investors are doomed to high commissions, endless paperwork and a truly hopeless task when it comes to diligently tracking what they own.
The cause of this dilemma—modern portfolio theory—used sophisticated mathematical principles to suggest that a portfolio’s volatility could be kept in check by carefully selecting stocks that moved counter to one another. The argument suggested that owning 20 stocks provided ‘practical’ diversification and crossing 30 led to negligible benefits in reducing volatility. The truth is that ‘market risk’ always lurks around the corner and all that owning 20 or more stocks does is lessen the probability of loss. In a sense, the crash of 2008 destroyed the wise men who invented modern finance.
Not only did nearly every stock round the globe drop in price at the same time, all major asset classes fell together in total defiance of conventional market wisdom. In reality, risk arises when you fail to understand the business that you buy and pay a price in excess of what the company is worth. To quote Warren Buffett: “I want to be able to explain my mistakes. This means I do only the things I completely understand.”
Put in a sensible perspective, the essence is to
(This story appears in the 19 April, 2013 issue of Forbes India. To visit our Archives, click here.)
Allmost everybody (including Buffett) has given pointers to identify great business (moat,competitive ability,scalability etc) BUT nobody has ever (including Buffett) given pointers/methods to know what is the fair price of these great businesses. The key is to know this and this key is not reveled by anybody.
on May 11, 2013Sanjoy, the wisdom of the sage of Omaha is well put. however, who can claim to be a fraction of what he is tempramentally. And now his reach from President of US to GS CEO. Oh and before I forget - just a small thing called leverage - of 1.6 times which just magnifies his returns by a modest 60%. Regards
on Apr 9, 2013Leverage is what is not yours. Its borrowed from. Buffett is the largest \"leveraged\" player in this world by using what is not his i.e. insurance float ! In fact there is a good report recently released on how buffett actually generated returns on his stock and business portfolio email me at adcorp25@gmail.com if anyone\'s interested
on Apr 9, 2013