Unveiling the Secrets of Wealth Accumulation:
Wise Investments and Avoiding Costly Mistakes
The rich get richer because they don’t do dumb stuff. Now, my last video consisted of what choices to make as a new investor in the markets, and I want to continue that topic primarily because most veterans or those who have invested for a long time continue to make the same blunders over and over. I don’t want you to fall into the same trap. Listen to the end to hear what Warren Buffett has to say on this particular topic. I think it’s going to blow you away.
Dave Duley here, a 40-year veteran of the stock market, and once again, to give you sound advice that has been proven over and over. Yet, the average investor keeps falling for the same sales pitch. Last week, I had over five separate families come into the office with almost identical portfolios. It’s insane. Now, let me set the stage for you. Most investors want to know what their risk tolerance is.
They will answer something like this: ‘Well, Dave, I want to grow, but I lean more towards conservative or moderate.’ When asked to be more specific in terms of a percentage, they respond, ’75 percent conservative and about 25 percent they’re willing to take on in risk.’ I’ve never, in 40 years, had anyone from ages 30 to 70 say, ‘Dave, I’m all in, let’s shoot for the sky.’ In other words, they’re expressing to the advisor or the firm, ‘I’m more concerned about holding onto what I have than getting great returns.’ This sets the stage for what we see weekly in clients’ portfolios, which sets them up for failure.
Two major factors contribute to this, and both are psychological at their base. First is FOMO, the fear of missing out, and second is loss aversion. Fear of missing out gets us off the couch and into the same game, which is a great trait in anything we do.
So, being willing to work with a professional fiduciary is a great start. But next is risk or loss aversion. We know we need to invest for the future, but we are so scared of losses or giving back what we’ve worked so hard to save that we default to diversification. This means we bet on every horse in the race. Imagine going to a football or baseball game and betting that both teams will win. It sounds ridiculous. Welcome to the sales pitch of diversification. Let’s look at the first six months of 2023 and use two examples of diversification.
Let’s take the NASDAQ 100, also known as the Qs. By investing in this, you are betting on the top 100 non-financial companies with the largest capitalizations, primarily innovative and what most people refer to as tech-heavy companies. This year alone, the Qs are up over 45 percent. Yes, that’s right, 45 percent. If you had just bought the index, your hundred thousand dollars today would be $145,000 in just six months of 2023.
However, a deeper dive would show that if you remove the top seven companies from that hundred, your return would be closer to 19 percent. If we take Vanguard’s Total Stock Fund or Fidelity’s Total Stock Fund, which make up over 386 different companies, you’d be up about 16 percent. I would take 16 percent in six months any day, but look at what you’re leaving on the table. If you had bought just the top seven companies of the Qs index, your return to date would be over 100 percent. That’s right, you would have doubled your money in six months in 2023. Who are these companies? Microsoft, Nvidia, Apple, Meta, Tesla, Amazon, Google.
I can hear people right now exclaiming, ‘Dang, that’s 20/20 hindsight!’ And more importantly, had you owned these companies last year, you would have been down 75 percent in 2022. So, what’s the solution? It’s simple: listen to me. When asked about your tolerance, lean 95 percent toward risk aversion. In other words, express that you don’t want the same results as 2022, 2008, or 2001 when the market went through major downturns. Just as you bought homeowners insurance for your house or insurance for your car, boat, or expensive jewelry, cover your investments with insurance.
If I buy Apple stock, Nvidia, Meta, or Tesla, should I cover those positions with insurance? For most people, the answer is no. And my question is, why not? And more importantly, why doesn’t my advisor recommend that I do that? Instead, they recommend diversification to reduce risk across hundreds, if not thousands, of companies that 99 percent of investors out there today have no idea about—companies they don’t know if they’ll run well, if the products are any good, or if they’ll even be around ten years from now.
Diversity is not the answer; rather, it’s protection from fast-moving markets or situations that are out of your control, such as a car wreck, a fire, or an unexpected illness. These are the things you insure for. And it all has to do with your money, your investments, and your retirement. Covering risk and spreading risk are two different subjects altogether. I want you to take five minutes and listen to two of the greatest investors of our time on the subject of diversity. I’m very interested in your policies on diversification and also how you concentrate your investments.
I’ve studied your reports going back a good number of years. There have been years where you had a lot of stocks in your portfolio and one year where you only had three, in 1987. So, I have two questions. Given the number of stocks you have in the portfolio now, what does that imply about your view of the market? Is it fairly valued? Secondly, whenever you take a new investment, it seems that you never take less than about five percent and never more than about ten percent of the total portfolio with that new position. Am I correct about that?’ Well, on the second point, that’s not completely correct.
We have positions that you don’t even see because we only listed the ones above $600 million in the last report. Obviously, those are all smaller positions. Sometimes it’s because they’re smaller companies, and sometimes it’s because the prices moved up after we bought them. Sometimes it’s because we may be selling the position down. So, we have no magic number. We like to put a lot of money into things that we feel strongly about. That brings us back to the diversification question.
We think diversification, as practiced generally, makes very little sense for anyone who knows what they’re doing. Diversification is a protection against ignorance. If you want to make sure that nothing bad happens to you relative to the market, you own everything. There’s nothing wrong with that. That’s a perfectly sound approach for somebody who doesn’t feel they know how to analyze businesses. If you know how to analyze and value businesses, it’s crazy to own 50 stocks or 40 stocks or 30 stocks, probably because there aren’t that many wonderful businesses that are understandable to a single human being, in all likelihood. And to have some super wonderful business and then put money into number 30 or 35 on your list of attractiveness and forgo putting more money into number one just strikes Charlie and me as madness. It’s conventional practice, and it may preserve your job, but it’s a confession in our view that you don’t really understand the businesses that you own.
On a personal portfolio basis, I own one stock. It’s a business I know, and it leaves me very comfortable. Do I need to own 28 stocks in order to have proper diversification? That would be nonsense. Within Berkshire, I could pick out three of our businesses, and I would be very happy if they were the only businesses we owned, and I had all my money in Berkshire. Now, I love the fact that we can find more than that and keep adding to it, but three wonderful businesses are more than you need in this life to do very well.
The average person isn’t going to run into that. If you look at how fortunes were built in this country, they weren’t built out of a portfolio of 50 companies. They were built by someone who identified a wonderful business. Coca-Cola is a great example; a lot of fortunes have been built on that, and there aren’t 50 Coca-Colas. There aren’t 20. If there were, that would be fine. We could all go out and diversify like crazy among that group and get results that would be equal to owning the really wonderful one. But you’re not going to find it, and the truth is you don’t need it. If you have a really wonderful business that is very well protected against the vicissitudes of the economy over time, the competition—businesses that are resistant to effective competition—three of those will be better than a hundred average businesses. And they’ll be safer, incidentally.
Today, there is less risk in owning three easy-to-identify wonderful businesses than in owning 50 well-known big businesses. It’s amazing what has been taught over the years in finance classes about that. But I assure you that I would rather pick, if I had to bet the next 30 years on the fortunes of my family that would be dependent upon the income from a given group of businesses, I would rather pick three businesses from those we own than own a diversified group of 50. Charlie, what he’s saying is that much of what is taught in modern corporate finance courses is nonsense. Do you want to elaborate on that, Charlie?’ You can’t believe this stuff.
Modern portfolio theory and all that. It has no utility. Well, I mean, it will tell you how to do average, but you know, I think anybody can figure out how to do average in fifth grade. It’s just not that difficult. It’s elaborate, and there are lots of little Greek letters and all kinds of things to make you feel like you’re in the big leagues, but there is no value added. I have difficulty with it because I am something of a student of dementia, and I have we hang around a lot, but we ordinarily classify dementia on some theory structure of models. But modern portfolio theory involves the type of dementia I just can’t even classify.
Something very strange is going on. If you find three wonderful businesses in your life, you’ll get very rich. And if you understand them, bad things aren’t going to happen to those three. That’s the characteristic of it. By the way, maybe that’s the reason there’s so much dementia. If you believe what Warren said, you could teach the whole course in about a week.’ ‘Yeah, and the high priests wouldn’t have any edge over the laypeople, and that never sells well, right?’ These are the smartest, wealthiest people in the world today, talking about the ignorance of diversity. Charlie Munger, Warren Buffett, and Mark Cuban call it plain stupid, for lack of a better word. Don’t get caught up with a firm or advisor that is not willing to put the work into owning great individual companies that continue to outperform the competition that you use every single day.
Warren Buffett says it best when he says, ‘A great company is well protected against the backdrop of risk and time. They’re resistant to major competition, and three of those type companies will be better than a hundred average businesses in your portfolio, much less a thousand in a mutual fund.’
Listen, if you want to know more about how to reduce risk by owning individual companies instead of betting on every horse in the race, visit our website, join our newsletter, and we will walk you through the simplicity of owning great companies and protecting those positions. I want you to learn. Don’t be afraid to ask questions of your advisor or firm and say, ‘Why am I not participating in these types of gains? Why do you have me in all these mutual funds representing thousands of companies?’ Click below to subscribe so you can continue to get our videos as soon as they’re posted. Till next time.