von Dr. Nikolaus Braun
Dear Sir or Madam,
Diversification is the only true “free lunch” in capital markets. Accordingly, almost all professional investors—and most private investors in theory—embrace the concept of diversification.
However, what we see in practice often looks quite different. Some use the concept as little more than a marketing buzzword, only to ignore it or at least dilute it significantly. Others invoke diversification as a justification for assembling an expensive and/or nonsensical mix of investments.
Mistake No. 1: Pseudo-Diversification
Many investors simply buy dozens of stocks—believing that more is better. Self-directed investors, in particular, often end up with an unmanageable assortment of individual securities that once seemed attractive to them. However, the way these stocks are distributed across regions or industries is usually just random.
In practice, we frequently see a massive overweighting of certain industries or the classic home bias. For example, German investors often hold predominantly German stocks, despite Germany making up only 2.0% of the global capital market. The reasoning is, of course, familiarity—but that doesn’t help if, as I can’t stress enough, you don’t have an informational advantage over other market participants.
Mistake No. 2: Overlap
Another common pitfall looks like this: You buy half a dozen or even a dozen funds, which ultimately all do more or less the same thing—investing in the same top positions. The result? Certain industries or regions become significantly overweighted, while others are almost entirely missing from your portfolio. In the end, you don’t even know what you’re actually invested in.
Under the label of a “core-satellite strategy,” the satellites often turn into a collection of trendy, eye-catching investments. Moreover, actively managed funds increase the risks and costs of your portfolio without offering a predictable added value.
Mistake No. 3: Opaque and Counterproductive Asset Classes
It makes no sense to include asset classes that inherently offer no interest or returns. A company owes an investor a risk premium—whether in the form of dividends, stock price appreciation, or, if you lend the company money, interest payments.
Commodities and currencies, on the other hand, may rise or fall in price, but unlike stocks or bonds, they don’t provide a risk premium to investors. Investing in them is a classic zero-sum game—one person wins, another loses. In the case of commodities (except for gold), massive storage and handling costs add another layer of inefficiency. After all, you can’t just store €50,000 worth of oil or steel in your basement.
Be Wary of the Hype
Anything that is marketed as groundbreaking, super-innovative, or incredibly smart is usually just expensive nonsense: Cat bonds, mezzanine financing, long-short strategies, event-driven strategies, hedge funds, complex certificates, total return or guarantee products—these primarily benefit the product providers or institutional professionals.
And even if some of them have worked in hindsight, these products are entirely non-transparent. Chances are, you simply got lucky—because you have no real idea what risks you actually took on.
Now you know the fundamental principle of diversification and how to avoid the biggest mistakes. In the next installment, I’ll show you what a rationally diversified portfolio actually looks like.
Best regards,
Your
Nikolaus Braun
Neunundvierzig Honorarberatung
16/09/2023
