When has below average ever been good enough?
You wouldn’t settle for a below-average brain surgeon or below-average teachers for your kids, so why settle for below average with your investment portfolio? And if you’re playing the Wall Street diversification game, below-average is exactly what you can expect.
In a mathematical sense, diversification is meant to accomplish one goal – to spread risk. It’s a risk minimization strategy, not a wealth-building strategy.
In Wall Street terms, the benchmark for measuring “average” is the S&P 500 index. So if you want to achieve average returns, all you have to do is buy into an S&P index fund.
If you want to beat the market with your diversification strategy or through a financial advisor or mutual fund, the stark reality is you’ll most likely fail.
According to JP Morgan Asset Management, the average annual return earned by a retail investor for the 20 years between 1999 and 2019 was 1.9% – a -.3% return when accounting for inflation.
Those who turn to financial advisors and mutual funds don’t fare better than going alone. 92.25% of financial advisors do no better than the S&P 500.
In other words, you can invest in an S&P 500 index fund and do better than 92.25% of all financial advisors. The returns from mutual funds are worse. 96% of mutual funds have failed to beat the market over the past 15 years.
Wall Street is a road to mediocrity.
The most common diversification strategy is to spread assets among various domestic and foreign stocks, bonds, and index funds to spread risk. Diversification may minimize risk, but what happens when the entire market tanks like during the Financial Crisis?
Diversification won’t save you in that scenario. You may be avoiding putting all your eggs in one basket by diversifying among individual stocks, but what you don’t realize is that you’re still putting all your eggs in the one big basket of Wall Street.
Sophisticated investors don’t put all their eggs in the Wall Street basket.
As I explained, diversification is a road to mediocrity. It’s a risk minimization strategy – not one for building wealth. Sophisticated investors don’t want to preserve assets; they want to grow them. While the average is suitable enough for most investors, sophisticated investors have found that not only can they beat the market but also reduce risk through alternative methods – namely passive income-producing alternative assets.
Sophisticated investors would rather be specialists than generalists.
Wouldn’t you rather have a specialist than a generalist operating on your brain? There’s value to specialization because you know the neurosurgeon was specifically trained for this type of surgery and will have a higher chance of success. The same principles are applied when investing. Specialization offers higher returns than the generalization of diversification.
Sophisticated investors understand – despite what the talking heads on CNBC might say – that you’re much better off making a few strategic investments in sectors that you know very well. You will be able to better monitor them closely, rather than spreading your capital around to “hedge your bets.”
Sophisticated investors aren’t diversifying for the sake of diversifying. They don’t diversify to minimize risk. Because they seek out passive income investments, diversification for sophisticated investors means preserving an income stream essential for building wealth – their true goal of diversification.
When exploring a new investment opportunity, sophisticated investors don’t ask themselves, “will this diversify my portfolio?”
These three critical questions are more important to them:
- Does this investment produce reliable, passive income?
Passive income allows the sophisticated investor to trade money for time. Passive income frees investors from trading time for money. Their income is no longer limited to the number of hours they work in the day.
Sophisticated investors don’t want a ceiling on their income, and passive income is the only way to break through that ceiling. They seek out investments that cash flow.
Cash flowing businesses, real assets, agriculture, and commodities can all provide passive income essential for building wealth.
- Does my principal have a chance of growing exponentially independent of Wall Street?
Sophisticated investors seek out investments that not only generate passive income, but that also offer potentially significant appreciation.
That’s why they seek out tangible assets that are non-correlated to Wall Street.
Tangible assets like commercial real estate, businesses, agriculture, and commodities, offer appreciation – all backed by a tangible asset.
Real estate can easily double or triple over 7-10 years, depending on the market. The right business enterprises, agricultural assets, and commodities also have the potential to multiply their value many times over.
- Can I leverage the expertise of others by partnering with them?
Sophisticated investors practice diversification, but the type of diversification they’re interested in will require leveraging the expertise of others.
They’re interested in diversifying across a variety of geographic locations, asset classes, compensation structures, and hold periods. They understand that if they invest in only one property in one location, their income stream will be exposed to risk associated with that property in that location.
If an acute economic disaster strikes in that location affecting that one property, they won’t have investments in other parts of the country to continue generating cash flow.
Because sophisticated investors don’t have the time to be an expert in a broad range of geographic locations or asset classes, they’re willing to leverage the expertise of others.
Investing in various private investment funds provides time-constrained investors the opportunity to invest across a broad range of geographic locations, asset classes, compensation structures, and holding periods that they would not be able to accomplish on their own.
If you’re #1 investment objective is diversification, then you can expect to achieve below-average returns. However, if your #1 objective is to generate wealth, then questions like whether the investment opportunity generates passive income, offer appreciation, and is shielded from Wall Street will be more overriding concerns than diversification.
For sophisticated investors, diversification means something entirely different than to ordinary investors.
To sophisticated investors, diversification is a means to an end – a means of preserving cash flow towards achieving the goal of wealth.
Mike
