Mostly it is large Losses which teach us about the Importance of Diversification

Monthly Market Commentary: September 1, 2016

My regular readers know very well by now that I consistently recommend investors to hold a diversified portfolio of different assets consisting of equities, bonds and cash, real estate and precious metals. The purpose of this diversification is to reduce the risk of heavy capital losses. Since nowadays, most assets are grossly inflated I am not so sure that this diversification is full proof anymore, but what I am sure of is that the strategy of owning different assets is the best option for the average investor. It is nonetheless pretty clear to me that if becoming ultra-rich is the objective, diversification is simply not an option.

A friend of ours, Charlie Bilello who is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts and who is the co-author of four award-winning research papers on market anomalies and investing was kind enough to share with us a paper entitled, Big Winners and Big Drawdowns. The paper is very interesting because it shows that people like Steve Jobs, Bill Gates, Jeff Bezos, Eric Schmidt, and Larry Page became incredibly wealthy by having almost all their wealth in just one business, which however, experienced repeatedly huge drawdowns.  

Bilello rightly says that, “All big winners have big drawdowns. Accepting this fact can go a long way toward controlling your emotions during periods of adversity and becoming a better investor.”  

I fully agree with Bilello that controlling one’s emotions during periods of adversity can go a long way toward becoming a better investor. The successful investor should also be aware that the mind-boggling long term performance of stocks such as Apple, Amazon, Microsoft and Alphabet are the exception and that they are not at all representative of the returns investors should expect from their portfolios. More so, as I explained above, diversification – well-understood disciplined diversification – can help investors to better control their emotions.  

There is a point that is important: We investors will not only experience higher volatility and lower returns on our assets in the next few years. We shall also have to endure vicious interventions by governments and central banks, which are nothing else but an increase in taxes on private property or, as I believe, a form of hidden expropriation. The right choice of the custody and geographical location of your assets will be increasingly important. Concerning the custody of your assets beware of massive fraud everywhere – see following link:  
https://www.bloomberg.com/features/2016-premier-cru-john-fox

Following last month’s discussion of Mrs. Stutzman I received quite a few comments. The majority of the comments condemned the behaviour of Mrs. Stutzman, which I actually support.          

My friend Nitin Agrawal who edits this report sent me a link, which goes a long way towards helping the understanding of  The Nature of Human Relationships. I strongly recommend my readers to listen to the words of Sahdguru:
https://youtu.be/Dl8MUnLfEsk  

Important Notice: The October Report may only go out on October 2. 

With kind regards
Yours sincerely
Marc Faber 

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