Diversification Or Diworsification
Freddie: Welcome to today's episode. In this discussion we'll explore the distinction and often misunderstood distinction between diversification and diworsification. While diversification is a key principle of sound, investing over complicating a portfolio can unintentionally dilute returns and increase risk, especially in retirement.
Hello again. I'm Freddie Bell and welcome to this episode of Leibel On Fire and with me is Leibel Sternbach. He is Amazon's bestselling author of Living with Financial Anxiety and also author of the book, Authenticity. Today we're looking at diversification and diworsification Leibel. Hello and welcome back.
Leibel: Hey, how are you doing today?
Freddie: Unbelievable. I'm so glad to be with you. Today we're talking about some great distinctions in how people are investing their money, especially in retirement, and I'm wondering if you wouldn't mind just starting us out with the difference between smart diversification and harmful diworsification in a retirement portfolio.
Leibel: Yeah, absolutely. So, diversification we're all familiar with it. It's, we own stocks and we own bonds, right? Because stocks go up and bonds, kind of go up a little bit, but when the stock market goes down, right? The idea is that hopefully people are gonna have this flight to safety and they're gonna go to those stable assets where your principal's guaranteed.
And so they're gonna go into bonds, right? And when they go into bonds, that's going to drive the value of bonds up in theory. And so you have this nice diversification. Diversification meaning that your losses, when you lose money, you don't lose as much money. And when you make money, you don't make as much money, but that you have this diversification that helps you kind of offset
the losses in one with the gains that you have in a different part of your portfolio. The biggest. Example of diversification is, holding the S & P 500 instead of just holding like the top seven stocks, right? So the top seven stocks, yeah,
they generate most of the returns in the stock market. But at the same time, at one point, Yahoo wasn't the top seven, right?
Freddie: That's true.
Leibel: They're at zero. So by holding, the top 500 stocks in the S & P 500 right? You spread across that loss so that as you have losers, you don't lose as much as you have winners, you don't win as much, but you get some kind of stable middle of the road return.
Freddie: Everybody we're talking with Leibel Sternbach. It's interesting that you can really get mixed up on these terms, but I'm wondering how can too much diversification actually reduce your income and growth for retirees? Can you outline that for us?
Leibel: Yeah, so really the issue is that, so when you have, when you're trying to diversify and you're like, okay, I don't wanna hold, I don't want half of my portfolio to be in Apple, right?
Or I don't want half of it to be in Tesla stock, right? You're like, okay, so let me give it to other companies and kind of the tool that most people reach to in order to do that diversification. Is they go to mutual funds or ETFs and they say, okay, I'm gonna give 10% of my money to this ETF, I'm gonna give, 10% to this one and 25 to that one.
And you build this portfolio of companies and stocks and ETFs that are managing your money. And sometimes people go and they'll say, even I'm gonna give some money to Wells Fargo and some to JP Morgan and some to the advisories down the street. And they think that by spreading all their money across all of these different investment vehicles, all these different money managers, that
somehow they're reducing the amount of risk they have in their portfolio because in their mind they go, well, if the market goes down or if one of these managers sucks, then it's not gonna affect all of my portfolio. But the truth is that there's a limited number of investment options in the universe, right?
Like we don't have an infinite amount of investments. And so when you go and you buy, one mutual fund or another mutual fund, in order for those funds to get the returns that they need to get, there's only a certain number of investments they can go after, right? It's not like, they have
one of them is planting soybeans and the other one is planting wheat, right? To get the returns they're both kind of planting wheat. The question is what proportion are they planting wheat versus soybeans? Or whatever it is. And so when you start t hinking of it that way, what happens is you end up with accidental overlap where maybe a whole bunch of the positions that you own, a whole bunch of those mutual funds are doing the same thing.
And so where you thought, oh, I'm gonna be, a moderate risk, I'm gonna be a 60-40. In reality, because of the overlap with all the managers, you end up being an 80-20. Because each of them are taking on a little bit more risk than you thought. Or they're taking on a different type of risk and they're taking on the same risk and none of them are talking to each other.
It's like this is why they're, the ETFs and the mutual funds are all independent. Your money managers at the different banks are all independent and they're all doing things on their own kind of whimsy and chances are they're probably kind of playing from a very similar playbook.
And so you end up with a portfolio that behaves in a way that you didn't expect, and oftentimes can be over concentrated, especially if the managers have discretion because all of a sudden if several of those managers go, well, you know what? I really think Tesla's the next big buy, or I think NVIDIA's the next big buy, and all of a sudden, each one of them make a bet in it.
Each of them only make a 5% bet or a 10% bet. But between all the five managers that you're hiring, all of a sudden you might have a 25% bet instead of a 10% bet
Freddie: Leibel, but aren't products like mutual funds and target date funds already diversified?
Leibel: So that is a great point. What is the definition of diversification?
And so when you think about an ETF and a mutual fund. Some of them may be diversified. The question is what are they diversified against? Are they diversifying against the same risks that you have? And the truth is that oftentimes right, they're diversifying themselves against the risks that they see, which may not be the risk that you see.
And especially when it comes to mutual funds and ETFs. They file their perspectives with the SEC and they say. This is how we're managing our portfolio. We're gonna be concentrated or we're gonna be diversified. If we're gonna be diversified, this is how we do our diversification. And so, yes, technically maybe it's diversified, but it's the overlap that you have between the managers that becomes a problem.
So if all you did was you held, one ETF or one mutual fund, or you held three or four of them and each one of them was in a different sector of the market, or they were in a different asset class, right? One was large cap. One was mid cap, one was fixed income, and one was equities, then you would be fine, right?
You would be fully diversified. The problem is as you start increasing the number of positions in your portfolio and you start buying things that have similar mandates to each other. All of a sudden you have this diworsification where you have this overlap that you have no idea that you have this overlap and you have no idea where this overlap is coming from or how it's gonna play out.
Freddie: Wow. So that's a real quandary. So how can we make this really easy then Leibel for the retirees? How can retirees simplify these portfolios while still managing their risk effectively? Is that possible?
Leibel: It is possible. The real key is to start with the end goal in mind, right? Like any good trader, you need to know why are you making the trade, right?
What is it, what's the reason why you're buying this position? Where does it fit into your overall portfolio? And what are your long-term goals, right? Why is it you're buying this thing? Is it you're buying it because this person has exposure to a certain type of asset class? And why are you even holding that asset class?
Where does it fit into your income plan, right? If you're taking income and you gotta answer those hard questions and those are the hard questions that really, people come to us to help us answer. Once you know the answer to that question, then it's okay, let me go shopping and see what tools fit into, my arsenal to be able to get me the outcome that I want.
And, if you want to keep a very simple portfolio, then you're probably gonna be limited to about five, maybe six positions. For the average investor who wants to manage it themselves, I'd probably tell you to stick to three, maybe four. And that would be about it.
You have your equities, maybe an international, maybe a fixed income, maybe an alternative, and that's it, right? Like, you don't need anything more. The issue is when you try to get outcomes that are not market related, right? Where you're trying to tamp down the volatility and get to a certain experience,
or you're trying to hedge against certain outcomes, right? You wanna make sure that you don't run outta money in retirement. That's where having more tools and more sophistication becomes important. And it's also where having more generally hurts you rather than having less. And it's more of the right thing, not the wrong thing.
Freddie: Makes a lot of sense. So can you tell us about resources that you may have at yields4u.com?
Leibel: Yeah, absolutely. So if you go to yields4u.com, we offer a free retirement tax analysis where if you want, we'll take a look at your portfolio, we'll take a look at what your holdings are.
We'll tell you what that overlap is and we'll help you kind of, give you an idea of, are you, diworsified or do you have true diversification? What are the changes that you can make to your portfolio? That will help make sure that you don't run outta money in retirement that get you generate the income that you want in retirement and make sure that you're doing it in a way that takes on the least amount of risk possible, right?
Because there's lots of ways to get to your destination. You can go at a hundred miles an hour and risk running into the guardrails and flipping over, or you can go at five miles an hour and maybe you get to your destination in time, maybe not so, the right answer is usually somewhere in the middle.
The question is at what speed do you start to feel uncomfortable? But what is the minimum speed that you need to go in order to remain safe?
Freddie: That makes a lot of sense and we'll leave it right there. And that website again is yields 4 U, yields, the number four, the letter u dot com. I'm Freddie Bell, and thank you again for joining us as we explore the line between smart diversification and harmful deworsification. In retirement, keeping your portfolio
simple, clear and understandable and purposeful can make the difference that you'll want in retirement. We'll see you next time.
