The Agony and the Ecstasy of Investment Portfolio Diversification & Diworseification

February 12, 2024

Everyone likes owning investments that go up.

No one likes owning investments that go down.

Most everyone understands too that portfolios should be diversified. They’ve at least heard the word—being that diversity is a buzz word in culture and in finance—even if they don’t entirely grasp what it means.

Jason Zweig, in his wonderful satirical dictionary, defines it this way: 

DIVERSIFY, v. To own a variety of investments with countervailing risks and returns, making your portfolio safer; most investors, however, di-worse-ify instead, making their portfolios more dangerous by buying lots of whatever has been going up lately. If all your holdings go up together, they have high CORRELATION and will also go down together. The word “diversify” comes from the Latin diversificare, to make different; to be diversified, you must own assets that sometimes make you feel good and sometimes make you feel bad.1

Diversification is a basic tenet of investing.

Therefore, those who diversify will not only have a diversity of investments but a diversity of emotions as they watch some holdings outperform and others underperform.

You can have too much of a good thing though. Zweig alludes to di-worse-ification. This can happen if you just buy a few things that go up and say, “See I’m diversified! I own Apple and Microsoft!” You may choose to do that but understand that there is correlation risk in owning similar companies in the same sector.

Diworseification can also take place in a portfolio that year after year does essentially nothing where losers consistently wipe out gainers. I’ve seen portfolios with so many different positions that it’s hard to get a handle on what a person owns and what is even happening amidst the plethora of stocks, bonds, and funds. It’s like being so overmedicated that the various side effects from all the drugs in the system seem to cancel out any positive remedies!

Charlie Munger, Warren Buffet’s right-hand man who recently passed away, was not generally speaking a fan of diversification. 

The idea of diversification makes sense to a point if you don’t know what you’re doing and you want the standard result and not be embarrassed, why course you can widely diversify. Nobody’s entitled to a lot of money for recognizing that because it’s a truism it’s like knowing that two and two equals four. But the investment professionals think they’re helping you by arranging diversification. An idiot could diversify a portfolio!…

It’s perfectly possible to buy only one thing because the opportunity is so great and it’s such a cinch…So the whole idea of diversification when you’re looking for excellence, is totally ridiculous. It doesn’t work. It gives you an impossible task. What fun is it to do an impossible task over and over again? I find it agony.2

Charlie is brilliant. Not many of us though are Charlie Munger or Warren Buffett.

Consolidated portfolios in just a few positions can have massive growth. I’ve shown before how individual stocks can supercharge (and spoil) an investment portfolio.

No one will argue that there is ecstasy when one goes big and chooses the right couple stocks, but there is also great agony—when having never been diversified—one chooses the few that seemed right at the time yet in the future went terribly wrong. 

Remember Buffett himself has made some big mistakes.

Wasn’t it an old Jedi Master who said, “Choose wisely—you must—young padawan.” Wisdom for those who haven’t reached the investment heights of Yoda status seems to be found in keeping several eggs in the proverbial basket and not only chasing the golden ones.

To use Charlie’s bold language, there are diversified “idiots” and under-diversified “idiots”. Wise investors can exist on a spectrum when it comes to diversification.

If you are curious about whether you or your parents or your friends and family are diversified too much or not enough, have them reach out to us and do our risk assessment.

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Sources: 

  1. Zweig, Jason. The Devil's Financial Dictionary (p. 75). PublicAffairs. Kindle Edition.
  2. Accessed online: https://acquirersmultiple.com/2019/08/charlie-munger-diversify-portfolio/