Don't Run the Risk of Di-Worsification

One of my early influences, as a young finance journalist and investor trying to make sense of the markets, was the author and former fund manager Peter Lynch.

Lynch, as manager of Fidelity’s Magellan Fund, was a rarity (then and now). He consistently outperformed the S&P 500 for more than a decade, between 1977 and 1990. Keep in mind, that period was every bit as volatile and uncertain as our own. It encompassed a moribund 1970s stock market, periods of high inflation, high interest rates, a couple of recessions, and a stock market crash.

And through that whole time, he averaged a market-beating 29 percent average annual return.

He was also a great writer. His book “One Up on Wall Street” described an investing strategy he actually hated, but one that’s still key to the retirement assets industry today.

It’s the simple strategy called diversification.

In basic terms, the more stocks the fund manager owns — the more he spreads out his portfolio across many different companies — the less risk he takes.

But as I mentioned, Lynch hated this strategy — in fact his derisive term for diversification was di-worsification.

Let me explain why…

Basically, diversification means you’re less likely to lose a lot of money, but it also means you won’t make much either.

And John Shubert, the creator of the Alpha 15 Portfolio (which we will discuss in detail in future posts) and a veteran consultant to many pension funds and Fortune 500 employee retirement plans, knows the diversification mantra all too well.

Fact is, he’s had a ringside seat to the diversification debate for years.

He told me as much during one of our first meetings this past summer in New York City. 

(Side note: I actually had the opportunity to film some of these meetings and interviews while we met in New York and I will be posting them shortly as part of your VIP Primer Series . . . so keep an eye out for these videos.)

When we met, John was clear, fund managers are smart people. They can pick winning stocks. And after peering inside their portfolios for more than two decades, he should know what he’s talking about.

John noted that, out of say 100 stocks, these managers quite often have a handful of great, high-performing stocks. Yet those gains barely register in the fund’s performance, because the other 95 positions are generating average returns at best.

Why? Over-diversification.

Quite simply, spreading a fund’s money out over a hundred positions or more is the safe way for fund managers to do their jobs — and to keep their jobs.

And as you’ll learn over the next few days, a fund manager isn’t paid to beat the market and make outsized returns for investors. They get paid to not lose too much money when the market is down and to not make big profits when the broader market is up.

You’re probably scratching your head now, wondering why a fund manager would be paid to be mediocre.

Well it’s because of a flawed concept called Modern Portfolio Theory (or MPT, for short).

As John noted in my meetings with him in New York, MPT is gospel

It’s the bedrock of every decision to buy or sell any stock, in the big-money world of retirement assets. And the whole point of MPT is to measure the amount of “risk” in a fund manager’s portfolio.

Keep in mind, there are legions of risk consultants who go around applying MPT to mutual funds. In fact, much of their work goes into the “star” ratings (1 star, 2 stars, etc.) that Morningstar and other firms publish about mutual funds. These are the ratings that pension managers, retirement planners, and everyday investors rely on for deciding which mutual fund will get their (or their clients’) cash.

So for instance, let’s suppose a mutual fund manager has a great year and actually beats his benchmark index by a large margin. These risk experts, applying MPT’s mathematical models, might well deem the fund as having too much risk.

After all, how else could it beat its benchmark (like the S&P 500 for large company stocks, or the Russell 2000 for small company shares). Later, when pension managers decide to allocate their billions of dollars, that manager’s fund has a good chance of missing out on a large share of that cash.

The bottom line is that MPT is the yardstick. It’s how the mutual fund industry keeps score.

And while that’s great for them, it’s not great for you — because it means you're stuck with years of substandard returns on your hard-earned retirement dollars.
That’s why diversification is, as Peter Lynch put it, di-worsification.

This is yet another reason why John, Steve Forbes, and myself, in partnership with Newsmax, have put together this Investment Crisis Summit. We’ll lay even more of these retirement roadblocks out for you to see. And my team will also show you how to sidestep them with a revolutionary way to invest that could have you adding profits without adding risk.

More on that shortly, so stay tuned to this VIP Primer Series as we get you ready for this groundbreaking event on November 6.  

To your wealth and prosperity,

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Jeff Yastine
Financial Director, Newsmax Media