Bad Investments

Via Atrios, the Times sheds a tear:

For James E. Cayne, the firm’s chairman and former chief executive, holding on to his Bear stock was a point of pride, and he rarely, if ever, sold. A billionaire just over a year ago when Bear’s stock soared past $160, his 5.8 million shares are now worth about $28 million at Monday’s closing price of $4.81.

Well, I'd take $28 million. More to the point, keeping such a huge proportion of your savings in stock of a single firm is obviously bad investment practice. Very bad, in fact. Strange that a big-time financial wizard wouldn't know the first thing about the need to diversify.

Comments

Cayne is a dickish, pot-smoking, bridge-playing sorry excuse of a successor for Ace Greenberg. One of the few wonderful parts of this collapse.

Posted by Greg | March 18, 2008 2:48 PM

At least it's nice to see a CEO suffer for his failures, even if he still is ending up with large fortune.

Posted by Helter | March 18, 2008 2:49 PM

"Strange that a big-time financial wizard wouldn't know the first thing about the need to diversify."

Um, the guy was making a point, that he believed in his company. Would you invest with a guy who didn't invest in his own company? Though, in a fairer world, Cayne would have lost everything.

Posted by Alan Vanneman | March 18, 2008 2:51 PM

I didn't really see anything in the article backing up the contention that Mr. Cayne was keeping "such a huge proportion" of his savings in Bear stock. For all the article tells us, he might well possess hundreds of millions in other holdings financed via a big part of his (no doubt very ample) salary over the years. Perhaps he was worth $1.6 billion back in the day, and now he's worth a mere $700 million. Or perhaps I read too cursorily.

These Wall Street boys always seem to know how to look out for number one.

Posted by Jasper | March 18, 2008 2:53 PM

I can't tell from the article how much money Cayne had, so it's hard to say whether he was diversifying or not.

Of course it's really bad not to diversify, unfortunately a lot of the funds that investors THOUGHT were risk diverse, turn out to be pretty interrelated.

And I'd rather have a rational financial planner as the manager of my investment firm than a homer, yes, any day.

Posted by Tony V | March 18, 2008 2:56 PM

Two points:

(1) We don't really know how much of Cayne's wealth was tied up in BS.

(2) Many companies require their execs to hold on to stock because it's supposed to align their interests or something. Do we know what sorts of policies were in place at BS?

Posted by blah | March 18, 2008 3:00 PM

Cayne was dick. It's a sad irony that his bridge playing helped him get the job at Bear in the first place, and then decades later he was out playing bridge when the company collapsed.

I can't fault him for keeping that much stock in his own company though. That's a point of pride for a lot of workers. I once dealt with some linemen at a publicly-traded utility and they were all proud of how many shares in their company they had accumulated in their 401(k)s. As it happened, their utility smoked all the major stock indexes over the last several years, so they lucked out with that allocation.

Posted by Fred | March 18, 2008 3:01 PM

The best part was further down the article: some of the execs are so hard up for cash, they are actually being FORCED TO SELL THEIR WEEKEND HOMES.

Cry me a river.

Posted by Anderson | March 18, 2008 3:01 PM

Well, maybe someone will track down how much Cayne did "cash out" of Bear during his tenure as CEO. I'd be pretty surprised if it was much less than $200M.

If so, then what exactly is the margin difference in your life-style between being worth (say) $528M and being worth $228M?...

Posted by RKU | March 18, 2008 3:01 PM

I would imagine that all (and more) of that $28mm has been pledged to finance homes and other goodies (maybe a jet?) -- he doesn't end up with $28mm, rather he ends up in bankruptcy.

Posted by mike c | March 18, 2008 3:03 PM

what in the article compels the conclusion that Cayne did *not* diversify? As the "firm’s chairman and former chief executive," I'm sure his yearly wages were in the millions. What indication do you have that he failed to diversify any investments made with that money?

I know, it was a fun shot to take at this clown, and the NYT's article was ridiculous, but your shot was cheap & ill-informed.

Posted by MY Strikes again | March 18, 2008 3:03 PM

Employees owning stock in their own employer is idiotic, especially if it dominates their portfolio. Would have thought everyone learned their lesson after the Enron fiasco.

Posted by lfv | March 18, 2008 3:04 PM

Perhaps he didn't diversify 'cos he new his stock was overpriced and couldn't risk jail time by unloading.

Posted by Gunga Dean | March 18, 2008 3:07 PM

The best part was further down the article: some of the execs are so hard up for cash, they are actually being FORCED TO SELL THEIR WEEKEND HOMES.

Cry me a river.

Posted by Anderson | March 18, 2008 3:09 PM

Not to be too coarse but f%ck this guy with a waffle iron.

Bear Stearns employees who had half a million dollars in BS stock (heh) squirreled away for their retirement now have $15,000 thanks in no small part to the suckitude of James E. Cayne. I hope he gets a papercut playing bridge that turns into gangrene.

Posted by joejoejoe | March 18, 2008 3:16 PM

Meanwhile, Goldman's up 15% today and Lehman's up 42% after their earnings calls.

Posted by Fred | March 18, 2008 3:16 PM

virtually all of warren buffett's net worth is in berkshire hathaway stock, which is not only a matter of eating your own cooking but also a reflection of buffett's believe that "diversification" is overrated.

in particular, buffett would argue that you should only invest within your circle of competence, that no one can have a circle of competence big enough to be truly "diversified," and that you're better off focussing your investments.

buffett's mentor, ben graham, wrote in the intelligent investor that adequate results are easier to achieve than most people realize and superior results are harder to achieve than most people realize.

if you're after adequate results, then buffett would certainly agree that buying an index fund is a good idea, and you achieve diversification that way.

but if you're after superior results, buffett says concentration is the way, not diversification.

PS. it is fair to note that berkshire hathaway is, itself, quite diversified: the businesses berkshire owns have only one thing in common - they all generate lots of free cash flow.

Posted by howard | March 18, 2008 3:17 PM

He was locked up from selling.

In all likelihood, he levered up using the BSC stock as collateral to fund the cash for his lifestyle - which means an unpleasant margin call on the horizon...

Posted by Chris | March 18, 2008 3:24 PM

You know what they say, better to have made a billion dollars and lost it than to have never made a billion at all.

I wonder if he'll be using his remaining $28 million to help out the employees he helped screw over. Methinks not.

Posted by How Insane Is John McCain? | March 18, 2008 3:24 PM

"PS. it is fair to note that berkshire hathaway is, itself, quite diversified: the businesses berkshire owns have only one thing in common - they all generate lots of free cash flow."

"It is fair to note" is the mother of all understatements here. Berkshire is a holding company that includes dozens of profitable, wholly-owned operating companies in different industries (everything from Israeli steelmaker Iscar to GEICO to See's Candies, etc.), a diversified portfolio of high-quality, publicly-traded stocks, and $50 billion in cash that Buffett can use for new acquisitions or special situations. Bear was a highly-leveraged I-Bank unable to weather a liquidity crisis. If Cayne didn't have his head up his ass playing bridge all the time, maybe he would have tried to reduce Bear's leverage some since August.

Posted by Fred | March 18, 2008 3:27 PM

Diversification is overrated. In fact, it's almost impossible to do. When there's a crash, everything goes down. And that's part of the reason for the current chaos: the finance whiz-kids thought they had computer models which told them that asset type A would go down when asset type B would go up, and vice versa, so by their theory you could take a risky package of type A investments and a risky package of type B investments and bunclde them together to make a safer (less volatile) investment. And that works great, until something unexpected happens (like $110 oil) and everything crashes at once.

Anyhow, if Cayne is smart he will have sold enough stock to maintain his lifestyle. If he's as dumb as he appears, he will have borrowed hundreds of millions with the stock as collateral, and he'll have to hold a firesale and end up bankrupt. From past scandals it seems that most CEOs who find themselves in such a mess are really dumb.

Posted by Richard Cownie | March 18, 2008 3:27 PM

Like many other firms on Wall Street, Bear pays out bonuses heavily in stock and various restricted stock units. The firm’s compensation ratio rocketed higher in 2007, when it paid out salaries and bonuses to the tune of 57.6% of its net revenue, up from 47.1% in 2006.

And many Bear Stearns’ bankers are are least partially locked in for two reasons: the vast majority of their earnings is related to stock held up in lockups of three to five years–and employees can’t sell stock right now because of the longtime lockup periods before and after earnings announcements, and Bear is scheduled to announce earnings Monday morning. Can you say “stuck”?

http://blogs.wsj.com/deals/2008/03/16/bear-stearns-can-its-investment-bankers-find-a-job-in-this-market/

Posted by blah | March 18, 2008 3:35 PM

"Diversification is overrated. In fact, it's almost impossible to do. When there's a crash, everything goes down. And that's part of the reason for the current chaos: the finance whiz-kids thought they had computer models which told them that asset type A would go down when asset type B would go up, and vice versa, so by their theory you could take a risky package of type A investments and a risky package of type B investments and bunclde them together to make a safer (less volatile) investment. And that works great, until something unexpected happens (like $110 oil) and everything crashes at once."

What threw off the whiz-kids' models wasn't the price of oil, but the downside of leverage. Margin calls forced highly-leveraged long-short hedge funds to sell the sort of value stocks that they would normally want to buy in this sort of market. That has led to some bargains for un-levered investors with cash on hand.

Posted by Fred | March 18, 2008 3:39 PM

Has it occurred to anyone he likely has untold millions salted away in Lichtenstein?

Posted by steve duncan | March 18, 2008 3:40 PM

virtually all of warren buffett's net worth is in berkshire hathaway stock, which is not only a matter of eating your own cooking but also a reflection of buffett's believe that "diversification" is overrated.

As Mark Twain said (approx), "Put all your eggs in one basket. And watch that basket."

Buffet's strength seems to be self-discipline and the capacity to understand people. He pointedly doesn't play the stock market.

Posted by Jeffrey Davis | March 18, 2008 3:44 PM

It is likely that Cayne was compensated in Bear stock a lot and was restricted in the amounts he could sell.

As for whether he was diversified in his other savings, who knows?

For a long-term investor, diversification is not overrated. In fact, it is, as someone once said, economics only free lunch. On average, over the long term, by diversifying you will receive higher returns with lower risk. This is indisputable.

And no, it's not impossible to do and no everything does not crash at once. For instance, right now as the stock market is falling, treasuries are rallying! Obviously, you want to be diversified over more than two asset classes.

True, historical correlations should be taken with a grain of salt but when that correlative history is 70 years long and your investment horizon is 20-30 years I'm not sure waht better information you think you can get.

So...buy five or six low-cost index funds in different asset classes with varying levels of correlation each with at least 10% of total portfolio value, hold, and rebalance to your original asset allocation percentage every two years. If you don't believe me, believe the guy who gets amazing returns for Yale every year:
http://www.amazon.com/Unconventional-Success-Fundamental-Approach-Investment/dp/0743228383

Posted by djslippyb | March 18, 2008 3:44 PM

As others have pointed out, it is not sure that Cayne had all his savings in Bear stock. Probably most of this holdings were a result of option grants so he didn't really have a choice. I am pretty sure he has a tidy (and very nicely diversified) portfolio somewhere. Rest assured he's not going to have to shop at Target.

Posted by 2cynicalbyhalf | March 18, 2008 3:45 PM

Buy CDs in Euros from and American bank backed by the FDIC.

Sure I'm an pseudonymous guy in blog comments but am I really less credible than Morningstar or Standard & Poor's? Also, always bet on grey horses. They're fast.

Posted by joejoejoe | March 18, 2008 3:49 PM

Fred, just for the rarity value, let me note that i completely agree that what we've seen at bear stearns is first and foremost a management failure, which is why the wall street journal has reported that jp morgan is assuming $6B as a set-aside for litigation.

if i were a bear stearns shareholder, particularly one who bought in recent weeks, i'd already be huddling with my attorneys.

but whether cayne made smart choices about his own net worth is a different matter than i was addressing about diversification. matthew recited the cliche that diversification is the way to go.

i'm merely noting that the greatest investor of the past 50 years does not think that diversification, as such, is the way to go. yes, berkshire is a diversified holding company, but it doesn't just diversify for the sake of diversification: it buys business with moats that generate free cash flow, either in whole (the preferred method) or in part (as stock market purchases).

it doesn't buy businesses that buffett doesn't understand, such as technology, and it doesn't buy businesses just to worship at the shrine of diversification.

as for bargains for unleveraged players with cash on hand: well, you couldn't ask for a better defintion of buffett (which i assume was why you said it). but he hasn't bought anything yet.

this leads me to conclude - or to put it another way, this confirms my conclusion - that there aren't many bargains yet, that the bargains are still a couple thousand dow points away.

Posted by howard | March 18, 2008 3:53 PM

djslippyb, this is turning into an interesting discussion about diversification.

as i noted, if you're after adequate results, diversification through index funds (or ETFs) is a good idea. indeed, fwiw, i have my money in two pots: half of it is in value-oriented mutual funds with low expense ratios, half in domestic and half in global, rebalanced annually; the other half i have half in berkshire hathaway and half in my pathetic little attempts to emulate the master.

so in comparison to many outcomes we can imagine, a diversified portfolio is a good idea as long as its on the level of index funds or ETFs.

but if it's superior results you're after, then there is good reason to argue that diversification is overrated, that superior results come from concentration and not diversification (it's somewhat relevant here to reference buffett's the super investors of graham-and-doddsville essay: http://www.tilsonfunds.com/superinvestors.pdf).

Posted by howard | March 18, 2008 4:03 PM

djslippyb,

"If you don't believe me, believe the guy who gets amazing returns for Yale every year"

Why? He didn't get his amazing returns by following that indexing strategy.

Howard,

"as for bargains for unleveraged players with cash on hand: well, you couldn't ask for a better defintion of buffett (which i assume was why you said it). but he hasn't bought anything yet.

this leads me to conclude - or to put it another way, this confirms my conclusion - that there aren't many bargains yet, that the bargains are still a couple thousand dow points away."

Two problems with your conclusion. First, Buffett has done some buying (e.g., BNI). Second, the universe of stocks Buffett is limited to is much smaller than that of other investors, because of his enormous asset base (i.e., he's limited to large caps). Investors who aren't similarly constrained can find a lot more bargains.

Posted by Fred | March 18, 2008 4:07 PM

Strange that a big-time financial wizard wouldn't know the first thing about the need to diversify.

Hmm. Cayne cashed out $15m on December 21 from exercising zero-dollar options and selling at $90/share. It's all in the insider buy/sell disclosure forms. Unless he bought a fuckload at Barney's for Christmas, he's pretty diversified.

Posted by pseudonymous in nc | March 18, 2008 4:11 PM

"(it's somewhat relevant here to reference buffett's the super investors of graham-and-doddsville essay"

That's a great essay everyone should read, but it's really an argument about the benefits of active value investing versus efficient market theory indexing; it isn't an argument for or against diversification. As Buffett notes in the speech, some Graham-influenced investors are concentrated investors, and others (e.g., Schloss) aren't.

Posted by Fred | March 18, 2008 4:14 PM

Fred, Buffett's been accumulating BNI for over a year now; i don't regard that as a sign that he thinks there are lots of bargains out there right this second (admittedly, if he were buying right this second, i wouldn't know it yet, but given that he wants to buy whole businesses first and foremost....).

your second point is somewhat well-taken: it's true that buffett doesn't care if a $100M business is selling cheaply. still, there's lots of writedown blood in the streets, but there isn't that much in equity value blood in the streets yet, so i stand by my belief that there aren't yet lots of bargains (ok, the market thinks that jp morgan got a bargain with bear stearns, but that wasn't a deal available to the rest of us, even if we were unleveraged players with lots of cash).

indeed, the interesting question to me is just how many unleveraged players with lots of cash there are: i own two of them, berkshire and microsoft. i suppose there are some hedge funds and private equity funds with stacks of cash, but really, are there that many players sitting on cash?

we know that corporate america has been acumulating greenbacks, so conceivably we'll see more consolidations of the jp morgan/bear variety....

Posted by howard | March 18, 2008 4:18 PM

It would be nice to see the liberal blogs take up the case for crucifying SEC chair, Christopher Cox, who proclaimed, in answer to a question about investment banks on March 11 that ``We have a good deal of comfort about the capital cushions at these firms at the moment,'' Cox told reporters.

How much sucker investment money was lost because of that statement?

This is Brownie redux. Get rid of the bozo.

Posted by roger | March 18, 2008 4:20 PM

"Hmm. Cayne cashed out $15m on December 21 from exercising zero-dollar options and selling at $90/share. It's all in the insider buy/sell disclosure forms. Unless he bought a fuckload at Barney's for Christmas, he's pretty diversified"

That's an interesting definition of diversification you have there, Pseudo: selling ~166k shares of BSC at $90 and watching your other ~5.5 million shares drop to $2. If Cayne is anywhere near as leveraged in his personal finances as Bear was, that $15 million might already be gone.

Posted by Fred | March 18, 2008 4:20 PM

"Strange that a big-time financial wizard wouldn't know the first thing about the need to diversify."

This is very unlikely. When you've been CEO and chairman, there's really not good time to cash out and treat a company you were intimately involed with as just another stock that could go up or down. Besides these are mega rich business people, not you average worker with a 401K. Top executives do sell stock in their companies all the time, but not just because they know you need to diversify. They usually try to argue or make it look like they're selling bits here and there for some liquidity needs.

Posted by Colatina | March 18, 2008 4:31 PM

"For a long-term investor, diversification is not overrated. In fact, it is, as someone once said, economics only free lunch. On average, over the long term, by diversifying you will receive higher returns with lower risk. This is indisputable."

Actually, I'll dispute it. Firstly, there's no such thing as a "long-term investor"; as Keynes said, in the long run we are all dead. If you held a bunch of different assets in Germany in 1920, or in the USA in 1928, or Japan in 1980, then everything tanked at once and you had to wait a long long time before you even got back to where you might have been by stashing cash under your mattress. Second, I haven't even taken into account the many countries which have suffered complete collapse of their economies and financial systems. If you have the misfortune to be "diversified" in a country which has a war or revolution or even just a big financial crisis, then you're screwed. And most of the studies which look at long-term returns for various investment strategies of course exclude such cases, precisely because there isn't a long continuous time-series of prices to try the investment strategy against. So they basically ignore a lot of systemic risks. And thirdly, those nice graphs which show various indexes growing through the decades tend to skate over the fact that the composition of the Dow (and other indexes) changes; they throw out the losers, and bring in the winners. And doing that for yourself - or even buying an index fund - introduces some transaction costs. Not to mention that when you buy an index fund you're trusting a financial company to do what it claims to be doing - and in the wake of Barings, LTCM, and Bear Stearns it's a big leap of faith to trust those guys.

Warren Buffett's approach is to be sure that he understands the businesses he invests in, and to be sure that they make real money - i.e. have strong positive cashflow, not just paper profits.
I'm pretty sure his success is not just due to luck; but then he probably has some unusually sharp analytical skills which the average joe can't match, so I'm not sure that example helps.

I have an alternative strategy which I'm way too chicken to put into practice: pick the ten companies with the highest market capitalization,
and bet they'll fall. In simple terms, my theory is that market capitalization arises from a combination of fundamental business strength, together with favorable investor sentiment; to be in the top ten you have be simultaneously very good *and* very fashionable. And to fall from such heights you just need become slightly less good;
*or* slightly less fashionable. Both of those events have rather high probability - staying at the top of the charts is really really hard - so
such companies tend to fall, just by reverting toward the mean in either dimension. But predicting just *when* it's going to happen is hard; and going short is not for the faint-hearted or the under-capitalized.

Posted by Richard Cownie | March 18, 2008 4:35 PM

"If you don't believe me, believe the guy who gets amazing returns for Yale every year"

Why? He didn't get his amazing returns by following that indexing strategy.

Because Swensen understands that it is impractical and costly for an individual investor to try to emulate the strategies of a tax-exempt, billion dollar endowment fund. Just as with Buffett, the same investment opportunities that are available to Swensen and the Yale endowment are just not available to the individual investor. It is unreasonable to think an individual can replicate their strategies.

Howard, I agree that if you were to buy one stock and only one stock, Berkshire Hathaway is probably you're best bet.

No doubt that superior results come from concentration but so do "superior" losses. The mathematical reality of diversification is that once you pick your risk tolerance, you can get a higher return for that risk if you are properly diversified OR once you pick your desired return, you can get that same return for a lower risk.

Posted by djslippyb | March 18, 2008 4:37 PM

Howard,

"indeed, the interesting question to me is just how many unleveraged players with lots of cash there are: i own two of them, berkshire and microsoft. i suppose there are some hedge funds and private equity funds with stacks of cash, but really, are there that many players sitting on cash?"

Outside of the financial sector, there are plenty of un-leveraged American companies sitting on piles of cash. I don't know if most of these count as "players" though, since they will generally only invest in their respective industries and are not investment companies. But they are worth considering as investments. These companies aren't limited to large caps either: here is a cash-rich small cap that I could see Buffett considering if he could buy small caps: Perini Corp. (PCR). It has an easy-to-understand business, a long history, lots of free cash flow, and a compelling investment thesis: the need for more infrastructure spending in the U.S. Check out what the valuation looks like when you back out the cash.

As for 'players', there are some mutual funds with relatively large (nowhere near as large as Berkshire's) cash allocations (e.g., The Fairholme Fund) and there is also over about two trillion dollars in money markets right now, IIRC.

Posted by Fred | March 18, 2008 4:42 PM

It's amazing the number of people who hold no illusions about competing on a golf course with a PGA pro who think they can beat the market.

Posted by demisod | March 18, 2008 4:46 PM

Fred, the key word is players indeed: i agree that there's lots of cash in corporate america (see my last sentence), and that there's lot of money market cash, but how much of that is on the prowl for generalized bargains.

i still think if i'm a big cash holder i sit tight longer and assume we can't possibly be at the bottom, especially if i look around and conduct this little analysis of how many other buyers are out there and determine not many.

perini, huh? i'll have to take a look: lou perini was the guy who took the boston braves to milwaukee, so i had heard of him long before i knew how he made his money. as a result, i've always had a vague interest in them, although not to the point of following them....

Posted by howard | March 18, 2008 4:57 PM

"The mathematical reality of diversification is that once you pick your risk tolerance, you can get a higher return for that risk if you are properly diversified OR once you pick your desired return, you can get that same return for a lower risk."

Under some fairly restrictive conditions, I daresay the mathematics holds true. But the theory of diversification doesn't really seem to deal with issues of systemic risk - whether war, revolution, natural disaster, or just a liquidity crisis. If
you're a risk-averse investor in 1929, what did the
theory of diversification tell you to do ? And how did it help ? Maybe diversifying gave you a
higher probability of having 90% losses rather than 95% losses; but really that's not much to
brag about. You got screwed either way.

In technical terms, I guess what I'm saying is that events in the long tail of the probability distribution can make a really big difference; that many of those long-tail events have systemic effects which defeat a diversification strategy; and that no-one has a good way of analysing, modeling, or predicting such events. So the mathematics of diversification works just fine if you assume that the asset-price distributions have a nice shape and consistent correlations. But quite often that ain't so, and then the theory doesn't help you a damn bit until the crisis is over.

Doubtless the experts would claim that it's more complex than this. But after LTCM and Bear Stearns, it's pretty clear that many of those experts have got it wrong.

Also Mark Twain's aphorism points out the downside of diversification: if you have your eggs scattered across many baskets, you can't watch them all carefully.

Posted by Richard Cownie | March 18, 2008 5:00 PM

fred, i just say your 4:14 (somehow i missed it before), and yes, i brought up superinvestors-of-graham-and-doddsville not as a point about concentration as such but as a point about superior returns and how hard and rare they are (although that said, all of the superinvestors could be said to be concentrated in the sense that they are not after diversification as such, they are after superior returns).

Posted by howard | March 18, 2008 5:03 PM

"perini, huh? i'll have to take a look"

See also the FT's Lex column yesterday on the bipartisan support in Congress for an infrastructure bank. And you may consider it an added plus that Perini got a "don't buy" from Cramer in a lightning round a few weeks ago (To be fair, he had a reasonable, though wrong rationale: that the problems with the muni bond market would slow local and state government spending on infrastructure. But in Perini's case, those governments are only about 13% of its business, and it has a huge backlog of business of about 1.5x its '07 revenue).

Posted by Fred | March 18, 2008 5:05 PM

Richard,

I'm not sure what you are disputing but it certainly isn't what I have asserted.

There are plenty of long-term investors. For instance, I am saving for retirment which will be in 25-35 years. Hopefully I will not be dead by then.

By diversification I am not suggesting holding simply a single index fund of your own country's stock market. You should be diversified across markets and be invested in both domestic and foreign equities, split among mature economies and emerging markets.

Yes, indexes change causing some churn in the portfolio but it is minimal and with Vanguard or TIAA-CREF for instance your cost is extremely low and their reputations are stellar.

Posted by djslippyb | March 18, 2008 5:12 PM

If Cayne is anywhere near as leveraged in his personal finances as Bear was, that $15 million might already be gone.

Well, in that case he deserves to be beaten with sticks.

My point is this: even if his BSC shares go to zero, he still cashed out fifteen million dollars three months ago. It's the definition of 'diversified' in which fifteen million dollars -- that is, 300 years of median household income -- is not exactly a side bet on five clubs. It even leaves him a nice lifetime income with half set aside to pay for any defense lawyers, should the need arise.

Posted by pseudonymous in nc | March 18, 2008 6:29 PM

"There are plenty of long-term investors. For instance, I am saving for retirment which will be in 25-35 years. Hopefully I will not be dead by then."

And if the current crisis turns out to be like
USA 1929 or Japan in the 80s/90s, that 25-year horizon won't be "long" enough for you, because
everythin will be underwater for 20 years or so.

Diversification is ok, and for sure, holding 10
stocks - or 5 stocks and 5 equities - gives less
risk than holding one. But its benefits are overstated - not least by people trying sell you stocks or funds because they make money no matter what happens to you ...

Posted by Richard Cownie | March 18, 2008 7:26 PM

Richard Cownie,

You are missing an obvious distinction between the U.S. in 1929, Japan in 1989, and the U.S. today: valuations. Before this recent correction, U.S. stocks were trading for close to the historic average P/E multiple of 16. Look up what the average multiples were for U.S. stocks in 1929 or Japanese stocks in 1989 (or U.S. stocks in 1999) and you'll see the difference. The key to avoiding disaster in one of these bubble situations isn't diversification, but having a value orientation. A perfect example is Bruce Berkowitz's Fairholme Fund, which started at the end of 1999. Compare his performance since then to that of the major indexes: Fairholme Fund versus Dow, Nasdaq, and S&P 500 since inception.

The Fairholme Fund didn't beat the indexes over this time period because of diversification; on the contrary, it has always been a concentrated fund. Currently, almost 70% of its assets are in 10 stocks, with more than a third in just two stocks. The reason why The Fairholme Fund avoided almost all of the 2000-2002 bear market (it was down about 2% in 2002, when the S&P was down 22%) is because, as a value investor, Berkowitz never bought any overpriced tech stocks to begin with.

Posted by Fred | March 18, 2008 7:53 PM

Dimson, Marsh and Staunton rerun most capital markets theory for a massively enlarged century-long worldwide dataset (which includes Germany and Japan, even though those markets didn't exist at certain points in time) and found most of the things that are true from earlier studies of the US capital markets are also true for the combined worldwide capital market in their book Triumph of the Optimists: 101 Years of Global Investment Returns. It makes sense if our other theories about finance hold upon analysis of this massive dataset, diversification will hold true as well.

Diversification of course doesn't prevent you from losing money in a situation like 1929 (and diversification isn't intended to do that) - the only thing that could do that is an incredible sense of market timing (or just plain luck). If you have that market timing, then you'll be a very great investor indeed. But that level of market timing is either extremely rare or effectively non-existant. Most people have absolutely horrid market timing - and often end up worrying that every market downturn is a repeat of 1929, causing them to miss every upturn till that upturn is almost over.

There were plenty of people in the 1950s muttering about how next year was going to be the next 1929.

Posted by burritoboy | March 18, 2008 8:07 PM

"You are missing an obvious distinction between the U.S. in 1929, Japan in 1989, and the U.S. today: valuations. Before this recent correction, U.S. stocks were trading for close to the historic average P/E multiple of 16"

I used to think "earnings" and "profit" were real concrete figures. Then I did the accounts for a (very) small business for a few years. And the truth is that "profit" is very heavily dependent on a lot of rather arbitrary accounting decisions: do you count stuff you've sold but haven't been paid for yet ? How do you value your goods in stock ? How do you depreciate your buildings and machinery ? How do you account for the man-years of effort put into developing software that might not ever get to market ? The rules for all those decisions differ from country to country; and the way those rules get applied differs from company to company; and they change from time to time. For example, the loophole about giving stock options to employees without counting it as an expense, which companies like Intel and Microsoft exploited to the max. And the "profit" as defined for tax purposes isn't the same as the "profit" as defined for public reports.

With all this, I have a lot of sympathy for Warren Buffett's view that free cashflow is a much more useful measure of a company's value. And I have a lot of skepticism for any quantitative analysis that claims to be based on "earnings"; the "earnings" figure is what you get by subtracting a very fuzzily-defined large number for expenses from a fairly fuzzily-defined large number for revenue, and if you think it means much you've probably already lost your shirt on Enron shares
(or Bear Stearns, come to that).

Beyond that, I also have great skepticism about the assumption that the USA's position in the future is going to be just like its position in 1950-2000. The USA had a period as the world's dominant economic power, and the dollar was the world's dominant currency. Now the EU matches the USA in GDP, and the Euro is a comparably strong -
on recent performance, much stronger - currency. While China is also clearly rising as a huge economic power. With these trends, together with the vastly increased mobility of capital, dollar-denominated assets just don't look as attractive as they used to. Running up a couple of trillion dollars in debt for a bunch of stupid taxcuts and a couple of stupid wars doesn't help either; and $110/barrel for oil is going to force some expensive restructuring of the USA's infrastructure.

Put together all these trends, and I don't think it's at all obvious that you can use 1950-2000 as a good basis for extrapolation to make predictions about the US economy of 2010-2020 and beyond.

Posted by Richard Cownie | March 18, 2008 9:34 PM

"Diversification of course doesn't prevent you from losing money in a situation like 1929 (and diversification isn't intended to do that)"

The advocates of diversification will claim that it
guarantees a better risk/return tradeoff - better
returns at the same risk, or the same return at less risk. But it seems to me that the "long tail" infrequent market crashes may well be a very large component of total risk. And actually with the increasing globalization of markets, those crashes are global these days, so unless you hold lunar and Martian stocks you still bear much of that risk.
So from this point of view I tend to think that the
advantages of diversification are greatly
overstated: better to hold a few good stocks that you understand than a bunch of stocks. Trying to achieve wider diversification seems like brushing your teeth regularly; it may reduce your risk of tooth decay, but do nothing for the more serious risks of cancer and heart disease.

Posted by Richard Cownie | March 18, 2008 9:48 PM

I'm surprised by how many people are surprised that Cayne held so much in BSC and perhaps didn't diversify much (although I agree with the commenters who suggest he probably had some other money kicking around). It's utterly standard in our economy for CEO/Chairman types to be heavily invested in their own company: Bill Gates at Microsoft, Larry Ellison at Oracle, etc. Part of the reason Gates is doing foundation work is that it's easier than trying to explain to people why he's selling his Microsoft and investing in other companies, and he gets to do something with his money other than count it (plus he helps a lot of people). Ellison is so heavily into Oracle that he passed Gates for richest guy on earth at the peak of the tech bubble, then crashed down to something lowly like $20 billion. There are some funny emails online from Ellison's accountant, yelling at him that he needs to sell some Oracle, stop borrowing so much against his stock, and start diversifying investments and paying for things with cash. Larry has finally taken the advice and is now selling a million shares a day, but he can only get away with it because he rode out the tech bubble and brought Oracle back to a strong stock position, and even after selling a million shares per day for months he's still holding over a billion shares.

As everyday investors, we should be happy that the bosses are invested in the same companies we are. Imagine how angry you would feel if Oracle crashed and you found out Larry Ellison had cashed out and invested his 20 billion in Wal Mart stock and a private island. Also, imagine the panic Oracle stockholders would face if Ellison said one day: "Here are my billion shares. I don't think this company is so hot any more - I'll take whatever anyone can put up for them". The sad part is that the entry-level schmoes at Bear Stearns probably don't have the NW to diversify and so they lose everything when the company falls apart, but at the same time they're soulless I-bankers and it's fun to laugh at them.

Posted by cgaros | March 18, 2008 10:26 PM

Richard Cownie,

"I used to think "earnings" and "profit" were real concrete figures..."

Yes, when investing in individual stocks one can't take earnings at face value and one must do further due diligence. Ben Graham spent a couple hundred pages on that point 74 years ago in Security Analysis. Point taken, but it's not really relevant to my point about the current stock market valuation compared to 1929 and 1999: if you used a less fudge-able metric such as price/sales or price/cash flow instead, you'd still see that the market today is far closer to the long-term average valuations than the stratospheric multiples that applied in '29, '99 or in Japan in '89.

"Beyond that, I also have great skepticism about the assumption that the USA's position in the future is going to be just like its position in 1950-2000..."

I see your pessimism about America, which isn't all that uncommon on the Left, but the fifty-year period you referred to included a period when a lot of people were even more pessimistic about America: the 1970s. Inflation was high, America's time had passed, New York City was bankrupt, etc. So few investors wanted to buy blue chip American companies that some of their stocks had dividend yields of 7% or more. Of course, that was a great time to buy and reinvest the dividends. And while people were moping around thinking America had its best days behind it, Bill Gates was dropping out of Harvard to start a little company with Paul Allen; Steve Jobs, fresh from finding himself in India, was starting another little company with Steve Wozniak, etc. That said, even though I'm bullish on America, there are often good opportunities elsewhere.

I've done well with a couple of international funds -- DODFX and TREMX -- but I wouldn't put more money in international markets now, for a couple of reasons. First, the weak dollar means you are getting less for your money than you will when the dollar strengthens (and it will, when the inevitable Fed rate increases start). And second, a lot of international markets have been on a tear the last few years, and you may be buying near the top. I suppose there are bargains if you pick and chose, but overall, prices seem more attractive here, especially in dollar terms.

Posted by Fred | March 19, 2008 1:34 AM

Richard,

That's not what diversification means. Even Markowitz, who first developed the efficient frontier, in his first papers clearly expects that ultimately the model incorporates ALL potential investment vehicles - that means not just the more traditional asset classes as equity and debt, but also all other potential asset classes. (You wouldn't have had much invested in the Weimar stock market because it was only a trivial part of the worldwide investment market unless you made the unusual decision to heavily overweigh German stocks).

That Markowitz used all potential asset classes was actually the initial primary argument against his work in the 1950s - there was no effective way then to invest (for the vast majority of people and even institutions) in a diversified portfolio of real estate, commodities, private equity, timber and so on. That's not true today.

Posted by burritoboy | March 19, 2008 7:09 AM

"Put together all these trends, and I don't think it's at all obvious that you can use 1950-2000 as a good basis for extrapolation to make predictions about the US economy of 2010-2020 and beyond."

Irrelevant. Unless you're making active investment decisions (which already makes you an active investor), EMT indicates that you should weigh individual investment opportunities at their current percentage of all investment opportunities. Therefore, our ideal investor would have been reducing his allocation to the US equity markets continuously since 1945, and his allocation to the British equity markets since the late nineteenth century.

Posted by burritoboy | March 19, 2008 7:19 AM

"Therefore, our ideal investor would have been reducing his allocation to the US equity markets continuously since 1945, and his allocation to the British equity markets since the late nineteenth century."

Which all sounds fine for an "ideal investor", but would have been just about impossible to do for any but the very richest until very recently (maybe the mid-1980s, with lower costs for moving money around, and more low-fee funds for foreign investment). So the theoretical benefits of the approach don't necessarily show up to the same degree in the real world.

To my mind, Mark Twain's aphorism applies with even greater force to investment in foreign markets - if you don't know the language and don't understand the local laws, customs, and politics in considerable detail then you're taking a huge risk because you can't watch your basket of eggs.
For example, China is obviously a big and fast-growing slice of the world economy, but I'd be really really nervous about putting any money into a place where the rule of law is at the whim of unaccountable officials in a one-party state.

And this theory is relatively comfortable for those in the USA - sure, diversify in proportion to the size of the various economies, and if you're in the USA you'll have a big bunch of assets in the USA. But if you lived in the UK, you'd need huge brass balls to consider moving the vast majority of your assets offshore and exposing yourself to currency risk, with your living expenses in sterling and your assets and income in other currencies.

Seems to me that economic conditions in the USA from 1950-2000 are a truly extraordinary episode compared to almost anywhere else at almost any other period of history. So while I admit the theoretical benefits of a modest degree of diversification (and you get most of the benefit from holding ten stocks instead of one), using the recent historical data to claim that it's a universal principle and a "free lunch" is rather misguided. Like LTCM's elaborate hedge strategy, it's a free lunch right up to the point where it suddenly isn't.

Posted by Richard Cownie | March 19, 2008 9:59 AM

"Therefore, our ideal investor would have been reducing his allocation to the US equity markets continuously since 1945, and his allocation to the British equity markets since the late nineteenth century."

Which all sounds fine for an "ideal investor", but would have been just about impossible to do for any but the very richest until very recently (maybe the mid-1980s, with lower costs for moving money around, and more low-fee funds for foreign investment). So the theoretical benefits of the approach don't necessarily show up to the same degree in the real world.

To my mind, Mark Twain's aphorism applies with even greater force to investment in foreign markets - if you don't know the language and don't understand the local laws, customs, and politics in considerable detail then you're taking a huge risk because you can't watch your basket of eggs.
For example, China is obviously a big and fast-growing slice of the world economy, but I'd be really really nervous about putting any money into a place where the rule of law is at the whim of unaccountable officials in a one-party state.

And this theory is relatively comfortable for those in the USA - sure, diversify in proportion to the size of the various economies, and if you're in the USA you'll have a big bunch of assets in the USA. But if you lived in the UK, you'd need huge brass balls to consider moving the vast majority of your assets offshore and exposing yourself to currency risk, with your living expenses in sterling and your assets and income in other currencies.

Seems to me that economic conditions in the USA from 1950-2000 are a truly extraordinary episode compared to almost anywhere else at almost any other period of history. So while I admit the theoretical benefits of a modest degree of diversification (and you get most of the benefit from holding ten stocks instead of one), using the recent historical data to claim that it's a universal principle and a "free lunch" is rather misguided. Like LTCM's elaborate hedge strategy, it's a free lunch right up to the point where it suddenly isn't.

Posted by Richard Cownie | March 19, 2008 10:00 AM

"But if you lived in the UK, you'd need huge brass balls to consider moving the vast majority of your assets offshore and exposing yourself to currency risk, with your living expenses in sterling and your assets and income in other currencies."

UK investors have been investing heavily worldwide for well over 100 years. In fact, such dominant US financiers as JP Morgan, Augustus Belmont, Villard and others were representatives of major European investors (the Brits through Morgan, the Rothschilds through Belmont, and the Germans through Villard). Such enterprises as American slave plantations, the American railroad system, the cattle ranches of Argentina, the railroads of Peru and rubber plantations in Burma were all funded by British capital in the late nineteenth and early twentieth century.

Posted by burritoboy | March 19, 2008 10:47 AM

"Seems to me that economic conditions in the USA from 1950-2000 are a truly extraordinary episode compared to almost anywhere else at almost any other period of history. "

Economic growth was significantly higher in the US from 1860-1929. Growth in Japan, for instance, from 1945 to 1989 was much higher than the US at the same time (starting from a vastly lower base, of course).

In hindsight, compared to the opportunities in defeated Germany or Japan in 1945, US investment opportunities were actually comparatively lower (i.e., you had to pay reasonable sums in 1945 for American economic assets. What turned out to be very substantive Japanese or German economic assets were essentially valued near zero in 1945. That wasn't an unreasonable conclusion for that historical moment, but it was actually wrong.)

Posted by burritoboy | March 19, 2008 10:56 AM

"UK investors have been investing heavily worldwide for well over 100 years. In fact, such dominant US financiers as JP Morgan, Augustus Belmont, Villard and others were"

Sure. But they weren't exactly your average joe
investing his retirement money. Global
diversification - in proportion to capitalization of
the various markets - isn't a feasible or attractive approach for small investors wanting to accumulate
wealth for domestic consumption. Which is most people, though perhaps not most of the money.

"Economic growth was significantly higher in the US from 1860-1929. Growth in Japan, for instance, from 1945 to 1989 was much higher than the US at the same time (starting from a vastly"

Well, I grew up in the UK in the 1970s, and saw stuff like the miners' strike, the three-day week, 15%+ inflation, IMF bailouts, frequent trade deficit problems, and the decimation of manufacturing industry in the early 1980s. And all that happened in a nation which had enjoyed its own period as a dominant economic and military power. So that experience tends to color my views. I was also vastly impressed by Fernand Braudel's works on world economic history, which make it clear that rapid economic growth is by no means inevitable, and indeed for most of human history growth has been almost imperceptible, and punctuated by cataclysmic declines due to famine, plague, war, and natural disasters. You don't know how lucky you have it. And there are a bunch of possible events which could screw things up really badly really quickly, e.g. climate change, avian flu, more war, disruption of oil supplies ...

I'm actually an optimist in that I believe that technology can solve or ameliorate many of these possible problems if the right economic incentives are put in place at the right time (e.g. a carbon tax or equivalent). But I do think it's going to be a rocky ride. And the USA in particular isn't going to be able to keep relying indefinitely on foreign investors to keep financing US domestic consumption, as has happened in a big way over the past few years.

Posted by Richard Cownie | March 19, 2008 11:26 AM

Um...that is the most intelligent series of blog comments I've ever read.

Posted by jmo | March 19, 2008 11:44 AM

Global diversification - in proportion to capitalization of the various markets - isn't a feasible or attractive approach for small investors wanting to accumulate
wealth for domestic consumption.

Not true. Go to Vanguard. They offer many low cost index funds or ETFs that will give you exposure to global markets - both emerging and developed.

Posted by djslippyb | March 19, 2008 11:56 AM

"They offer many low cost index funds or ETFs that will give you exposure to global markets - both emerging and developed"

I think you miss my point. Suppose you live in the UK and you're trying to accumulate wealth to fund retirement in the UK. A true believer in diversification would want to send maybe 95% of the assets abroad, to matching the relatively small size of the UK market as proportion of world markets. But that would expose you a serious currency risk: all your future expenses are in sterling, and if sterling goes up, but your investments are in non-sterling markets (especially dollars), then you're exposing yourself to a rather big systemic risk.

So global diversification makes more sense for someone in America - a big market - than for someone in the UK (or Argentina or Turkey or India or Mexico). Which is why I say it's over-rated - it isn't such a free lunch, it isn't very attractive for most people in most of the world, and if the USA follows the trajectory of the UK it might not look such a great idea for US citizens of 2050. It's a neat trick right now (or actually, for the last couple of decades, because past performance is no guarantee of future results) for people in the USA and perhaps also in the (very new) Euro zone. But it isn't a universal free lunch or a magic bullet or a law of nature.

Posted by Richard Cownie | March 19, 2008 12:28 PM

"Well, I grew up in the UK in the 1970s, and saw stuff like the miners' strike, the three-day week, 15%+ inflation, IMF bailouts, frequent trade deficit problems, and the decimation of manufacturing industry in the early 1980s. And all that happened in a nation which had enjoyed its own period as a dominant economic and military power. So that experience tends to color my views."

You just argued that people should invest in a few companies they know, rather than diversify according to modern portfolio theory. So, under your advice, most residents of the 1970s UK would likely be heavily allocated into big-cap UK companies (most people are not going to be able to locate good countercyclical small cap stocks)- i.e., precisely the type of companies that would be most unable to avoid the economic problems.

If they had been allocating according to modern portfolio theory, they would be much more internationally diversified (i.e. avoiding some of the idiosyncratic country risk of the 1970s UK) and perhaps thinking about how they could allocate to the emerging markets of the time - Japan, American junk bonds, the early mortgage bonds, etc.

Posted by burritoboy | March 19, 2008 12:43 PM

My experience with the british when it comes to investing is that they're incorrigible pessimists.

A static population and limited room to expand will inevitably result in a sort of economic stagnation that makes broad investment a bad deal-- an index fund is effectly investing your money in the GDP and taking advantage of that growth. Nations with expanding populations and/or modernizing economies are going to economically grow, and your returns in those sort of international funds will reflect that growth. The risk of losing money due to currency devaluation exists, but the truth is that in this sort of situation, it is the US (and, in the 80s, the UK) that has to worry about their currency devaluating, which creates an incentive to diversify through international funds.

Posted by Tyro | March 19, 2008 1:01 PM

"You just argued that people should invest in a few companies they know, rather than diversify according to modern portfolio theory. So, under your advice, most residents of the 1970s UK would likely be heavily allocated into big-cap UK companies (most people are not going to be able"

Obviously if I knew what I was talking about I'd be sitting on a yacht somewhere :-) But my general point is that big bad things happen, even to countries which have previously been wealthy. That diversification doesn't help with those risks, because under crisis conditions all the assumptions about (lack of) correlation break down; and that global diversification hasn't been - and isn't - a very practical approach for most small investors worldwide, because a) foreign markets funds are a fairly recent innovation and b) currency risk is a serious issue for most small investors saving for retirement.

I'm not utterly opposed to diversification; I just think its proponents are massively overstating its applicability and its benefits. Even for those who *can* do global diversification, the increasing interdependence of national economies means that if the USA ever sneezes, everyone catches a cold.

Posted by Richard Cownie | March 19, 2008 1:06 PM

"The risk of losing money due to currency devaluation exists, but the truth is that in this sort of situation, it is the US (and, in the 80s, the UK) that has to worry about their currency devaluating"

Well, if you lived in the UK and held a bunch of
dollar-denominated assets as global diversifiers would suggest, you'd be feeling pretty damn unhappy about the 30%-ish drop in the dollar-sterling exchange rate over the last 5 years.

Yeah, there are times when it goes the other way. But when the whole justification for the diversification approach is to *reduce* risk, you can't really just ignore the exposure to systemic currency risk. If you need to accumulate wealth in a particular currency, then you've got to worry about currency risk. It's a big risk; and it's a big risk that's going the wrong way *right now*.

Posted by Richard Cownie | March 19, 2008 1:19 PM

Tyro,

"A static population and limited room to expand will inevitably result in a sort of economic stagnation that makes broad investment a bad deal-- an index fund is effectly investing your money in the GDP and taking advantage of that growth."

I'm not a fan of index investing but what you've written is plainly false. First, British companies aren't limited to doing business exclusively in Britain; many of them do the majority of their business overseas. By investing in them, you are benefiting from those foreign earnings as well. Second, the returns on a country's broadest stock index aren't limited by the rate of growth of that country's GDP. That's never been the case. A country's publicly-traded companies are not representative of its entire GDP -- they exclude government entities and smaller non-publicly traded businesses that, overall, contribute less to economic growth, bringing down average GDP, and also include earnings growth generated in foreign markets.

Posted by Fred | March 19, 2008 1:23 PM

I agree if a meteor hits the world and destroys all mankind, diversification will not help. But that's not quite an argument for denying its very real benefits. You are throwing the baby out with the bath water.

Also, the risks you speak of are actually a lot more remote than the very real and common risks associated with holding a small portfolio of individual stocks.

Yes, the stats are historical but besides a crystal ball, what better do you have to go by? Did people mistakenly identify negatively correlated assets because their time series was short or they ignored the underlying fundamentals? Yes, but is it crazy to think that treasury bonds and the S&P 500 and emerging markets and europe and asian economies won't be perfectly correlated in the future? I don't think so.

I don't think any reasonable person would suggest someone in the UK to hold 95% of their portfolio in foreign assets. A sound well-diversified portfolio would include assets that protect against inflation, such as domestic inflation-adjusted bonds, domestic equities, and domestic real estate.

Here's an asset allocation I like:

30% domestic equities
20% foreign developed equities
15% emerging market equities
20% domestic real estate
10% treasury inflation protected securities
5% treasury bonds

Certainly, there are limits to the power of diversification but the fundamental benefit of diversification holds true. You can get the same expected return with lower variability or higher expected return at the same variability. You said yourself, that in 1929 diversification would have given you 90% losses instead of 95% losses. That's great especially when you don't have to pay for that protection with lower expected returns.

As an individual investor you are playing a loser's game as Charles Ellis puts it. You are up against enormous odds in trying to beat the market over a sustained period of time. The equity markets are very efficient. You are up against very well-financed hordes of very intelligent people who are actively trying to take your money. There is little reason to think as an individual you can ferret out the mispriced assets. Once you recognize what you are up against, your only hope is to play defense.

Your best bet is to gain exposure to different asset classes that are not perfectly correlated through the purchase of low-cost, passive index funds or etfs. Hold for the long term, adjusting the asset allocation every two years or so. Put as much as possible in non-taxable accounts. Cross your fingers.

Posted by djslippyb | March 19, 2008 1:31 PM

"I agree if a meteor hits the world and destroys all mankind, diversification will not help. But that's not quite an argument for denying its very real benefits. You are throwing the baby out with the bath water."

The benefits are real. They just aren't very large; and as far as global diversification is concerned, they aren't really available to most investors in the world.

And the downside of diversification is that the wider your diversification, the less chance you have of making any active decisions. Doubtless we can argue the merits of that. But if the goal is to buy low and sell high, diversification in proportion to capitalization just about guarantees that you never buy really low and you can never sell really high: you won't get into an emerging market until it's pretty big.

As my example of the UK in the 1970s suggests, bad things don't have to be anywhere near as dramatic as a meteor hitting the world. It took a while for the US markets to get over 9/11.

"I don't think any reasonable person would suggest someone in the UK to hold 95% of their portfolio in foreign assets."

Right. So when you come down to it, for most people a rigorous strategy of diversification is not a reasonable option at all.

I'm sort of grappling with an octopus here: we've got the theoretical, and mathematically sound, concept of diversification. But really hardly anyone can, or should, use that. And then we've got the rule-of-thumb seat-of-pants don't-put-all-your-eggs-in-one-basket approach, which doesn't have much theoretical basis but is justified by, well, I don't know what, exactly ? And kinda sorta does ok, mostly, unless you're unlucky enough to be doing it at the rare wrong time and place.

It's not terrible. But it's not all it's cracked up to be.

Posted by Richard Cownie | March 19, 2008 2:00 PM

"because a) foreign markets funds are a fairly recent innovation"

Not quite as true as people might imagine. In fact, the larger Florentine banks syndicated loans to entities like the English kings (who, by the way, repeatedly defaulted, causing the Peruzzi and Bardi banks to collapse), the textiles trade in Bruges and Ghent, the silver mines in the Tyrol, mercury extraction factories in Italy, trading international currencies, and so on from the 13th century onwards. The Fuggers, beyond their other activities, set up a private real estate investment fund that invested in many different principalities of Southern Germany. The Hochstetters of Augsburg had mining ventures (and had multiple external investors) in at least 4 countries, stretching from silver mines in Slovakia to copper mines in Northern England. The Hochstetters had external investors ranging from the Holy Roman Emperor and Queen Elizabeth to quite middle-class residents of their native city. The Acciaioli company had branches from Brazil to Athens.

Posted by burritoboy | March 19, 2008 2:47 PM

"Not quite as true as people might imagine. In fact, the larger Florentine banks syndicated loans to entities like the English kings (who, by the way, repeatedly defaulted, causing the Peruzzi and"

Interesting. But I'm working from the perspective of a small investor saving for retirement; and particularly a small investor who - like the vast majority of people - isn't living in the USA. And from that perspective, I think it was always pretty hard for the little guy to buy foreign investments perhaps until the 1980s ? from USA and Europe. And I have a suspicion that it's probably *still* pretty hard for the little guy in say, India or Mexico or Argentina, to buy foreign funds ? Though I don't have detailed knowledge on that.

You can correct me if I'm wrong on the history of this, but my impression is that mutual funds in general didn't really become widely-available products until the 1970s; and foreign-investment funds probably not until the 1980s. Partly because that was when pension provision started to change from employer-managed funds paying percentage-of-final-salary pensions, to individual pension accounts. And partly because a wave of financial deregulation shook up the whole finance business, at least in the USA and UK.

So really we're talking about a possibility that has been available to a small fraction of the world's investors for only about the last 30 years.

Of course, instead of buying stocks for