Diversification: Always Saying You’re Sorry

We’ve all heard it—diversification is spreading your eggs among many baskets. Jack Bogle phrased it as, “Why search for the needle? Just buy the whole haystack?”

Diversification has potential downsides too. If you buy a fund that has hundreds or thousands of holdings, be they stocks, bonds, real estate, commodities, digital assets—some will lose and over time, we expect that most will win.

What’s more, if you rebalance your diversified portfolio, you’ll inevitably sell some winners before they’re done winning this cycle and buy some of the losers before they’re done losing this cycle, even though rebalancing generally improves portfolio performance.

Another diversification axiom is, “Never make a killing, never get killed.” If we need to get rich and get out of the investing game, we need to make a killing and have the discipline to leave the game. (Protect the gain with much more conservative investing.) It’s not hard to imagine the siren song of continuing to seek further outsized gains, “I bought TSLA at $10 and now I’m a gazillionaire! I bet I can pick the next TSLA!”

Investing is about providing for our unknown future and life expectancy.  It’s close to an infinite game. Because “getting killed” or losing so much of our invested nest egg that we can’t provide for ourselves is losing an infinite game, it is not a risk to take. Thus, it’s better to not get killed than to make a killing.

Investor returns are highly individualized, but the long-term average of the stock market has been about 7% after inflation. Using the “Rule of 72” investors in diversified US stocks could expect such a portfolio to double about every 10 years.

Albert Einstein described compound returns as the “8th Wonder of the World” noting that those who understand this earn the returns and those who don’t pay the returns (in the form of interest and opportunity cost).

For example, a lieutenant that starts investing in an IRA in the year 2000 with $2,000 and earning an average 7%, increases the investment 3% per year for 10 years, then 5%, 7%, and 10% in each subsequent decade (as income grows) ends up with over $853K of inflation-adjusted dollars at the 40-year point, i.e., about the time s/he’s retiring.  That’s a pretty modest amount of investing and probably not enough to fully provide for retirement needs, but impressive nonetheless.

If the same lieutenant is married and invests in a spousal IRA too, the numbers grow to $1.7M.  Add in $5K of TSP/401(k) to the IRAs (nowhere near the maximum) and there’s over $3.8M of year 2000 spending power available in retirement. This could provide handsome retirement spending even without a military pension, VA disability compensation, and Social Security.

Is it necessary to make a killing if slow and steady could win the race / infinite game / provide for needs in retirement / avoid burdening kids? Diversified investing is an area where average is excellent over time.

Fights on!


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