| 9 Lowell Street, Beverly, Massachusetts, 0915-3652 - Phone 978.922.9961 - Fax 978.922-9961 Conflict Free Financial Planning, Investment Counseling & Financial Education |
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| Category Diversification Security Diversification Time Based Diversification |
| Philosophy |
Security Diversification
The more concentrated an investment portfolio is the greater the risk. If you only own one stock in your portfolio
your entire return is dependent on the return of that one investment. If it does well you do well. If it does poorly
your entire portfolio does poorly. Once you add another stock to your portfolio you lessen the impact of any one
stock on your results. The more stocks you add the less impact, good or bad, any one stock has on your
portfolio. The returns of better performing stocks are diluted by the other stocks while the losses of the poorly
performing stocks are offset to some extent if not entirely by the better stocks. Risk management is always
accomplished at the expense of returns.
Most professional investment managers whether they are managing corporate pension funds, charitable
endowments or mutual funds attempt to select only those stocks or bonds which they believe will generate
higher returns than the broader stock and bond markets and avoid those securities which will under perform.
They select these individual securities in an attempt to earn returns higher than the overall market. This leads
them to develop portfolios which are more concentrated than the broader stock and bond markets from which
they choose the securities for their portfolios. Unfortunately studies have demonstrated that few investors,
amateur or professional, are able to earn above average returns without taking above average risks. Even when
taking above average risks few investors are able to generate above average returns.
Rather than trying to pick the winners we avoid using individual securities and use low-cost index mutual funds.
Index funds are highly diversified in that they own most if not all of the securities in a particular market category.
Efficient markets and low expenses give index funds advantages few professional investment managers can
beat. Investors are able to earn the average return of the category while avoiding the risks of investing in a
more concentrated portfolio.
One of history’s most successful investors believes most investors are better off with index funds. In a Reuters
article published on May 6, 2007 Jonathan Stemple quoted Warren Buffett as saying “A very low-cost index is
going to beat a majority of the amateur-managed money or professionally-managed money”. Buffett went on to
say “The gross performance may be reasonably decent, but the fees will eat up a significant percentage of
returns,…You’ll pay lots of fees to people who do well, and lots of fees to people who do not do so well.”
The index fund portfolios we build for clients are all highly diversified across various categories of stocks and
bonds and hold thousands of individual securities. This approach protects our clients in the event adverse
developments hurt one particular stock or an entire category of securities.
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| 9 Lowell Street, Beverly, Massachusetts, 01915-3652 - Phone 978.922.9961 - Fax 978.922.9961 Conflict Free Financial Planning, Investment Counseling & Financial Education Adam Smith David Ricardo |
| Copyright © 2009 Thomas J. Costantini, Monserrat Advisory Services, LLC, All Rights Reserved. |