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The opposite of diversification.


Wealth – serious wealth – is most often created from a single successful investment. Just ask Bill Gates about Microsoft.

The all-eggs-in-one-basket approach is the opposite of diversification.

Wealth concentrated in one venture requires an entrepreneurial type with a high risk tolerance. But many small business startups end in bankruptcy. Start over. That’s ok for some.

For those with a low risk tolerance, wealth concentrated in a single venture doesn’t always work either. Ask investors about Loewen Group, Ballard Power, Laidlaw, Nortel, Bombardier, Bre-X or even Income Trusts. Some did well. Others failed miserably.

When a concentrated investment doesn’t work out, we re-learn that our risk tolerance is much lower than we thought.

Recall the CIBC lesson. On August 3rd, 2005 CIBC announced a $2.4 billion Enron related write-off. CIBC stock dropped 7.5% that day. By August 12th it had dropped 12.2%. Even blue-chip investments can surprise. For the risk-averse investor, this can cause an emotional sell decision – at which point, losses are locked in (my Accountant, with tongue in cheek, calls this ‘capturing a tax credit opportunity’).

For the risk intolerant, a single concentrated holding can mean inadequate diversification and excessive volatility. Not good.

Still other investors don’t have the ‘capacity’ for risk. They make big bets with nearly all of their wealth. Loses prove to be devastating to their financial situation.

Those with serious wealth never bet it all on a single investment. They bet 5%, say, with the hope of finding the next Microsoft. If that fails, there is still 95% to start over with. Assume risk with a small portion of your portfolio. The balance is a risk mitigating strategy for overall wealth (Sounds like the Core and Satellite approach we preach about).

What does Bill Gates do?

Since Microsoft went public, he has sold an average of five million shares every three months (about 80,000 shares a day – absurd, I know). He told Fortune magazine: “Since we are obviously heavily weighted with Microsoft, we will sell stock periodically in order to get more diversity. It’s basically the same strategy most individual investors engage in.”

Diversify? Like most individual investors? Bill Gates?

Bill Gates’ personal investment firm, Cascade Investment, has a mandate to collect diverse investments. The goal is to diversify away from the technology bias of the large Microsoft holdings by adding non-correlated assets – like Government Bonds. And, get this; non-Microsoft returns have averaged 8.53% annually since 1999. About average for a diversified portfolio.

Why would Bill Gates diversify?

Because now, for him, it’s not about getting rich, it’s about staying wealthy.

And that’s really the point. Capital markets can help preserve wealth already created. If you can stand risk, then, sure, bet it all on a single investment. If all is lost, start over. That’s ok for some. But if you do discover the next Microsoft, then to keep what you’ve made and grow it prudently – diversify.

For the rest of us, how about a globally diversified portfolio … and a lotto ticket?

Originally published in the Business Thompson Okanagan news, April 2007.

Doug Cronk CFA is Manager, Investments for a Canadian Pension Fund.

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