Don’t Listen to Warren Buffett

Originally published in 2017

“Diversification is protection against ignorance,” said billionaire investor Warren Buffett, famously. “It makes little sense if you know what you are doing.”

Well, that’s easy for him to say. Buffett attended the iconic Wharton School (of business) at the University of Pennsylvania at age 17 and by 19 had already graduated with a Bachelor of Science in Business Administration from the University of Nebraska-Lincoln. He then enrolled at Columbia Business School and earned his Master of Science in Economics in 1951. Within 10 years he was already a millionaire. “Arguably one of the greatest investors of all time,” Buffett is known as “the Oracle.”

But the rest of us are human. And there is ample evidence that — even if you do know what you’re doing, like, say, professional investor Jim Cramer — diversification works.

Diversification is not as much about protecting against “ignorance” (i.e., not knowing as much as Warren Buffett) as it is about protecting against the unpredictability of the global markets. Unless you, too, are an oracle, you probably couldn’t have forecast the ups and downs highlighted in this asset allocation chart:

Sure, you could’ve put all your money in Google. You might own an island today. But what if you had doubled-down on Enron, WorldCom or Lehman Brothers? You might be waking up on a park bench this morning.

So how do we make sure we don’t get killed by our own investments in any given year?

We mitigate risk — by simply following the (admittedly now clichéd) edict of Cervantes himself: “Don’t put all your eggs in one basket.”

The evidence is out there that diversifying your stock choices, even among small-, mid- and large-cap companies, is more likely to produce positive results over time. But that’s not enough. The chart above illustrates the correlation (or lack there of) among a variety of asset classes, including cash, bonds, commodities and real estate (as represented by REITs).

It’s worth noting that, from 1996 through 2015, real estate produced the highest average returns. But that’s not even the point.

As reported by Seeking Alpha, a popular investing site that derives its content not from sell-side analysts but from investors who’re actually “putting their money on the table:”

“Many investors are turning to real estate, and whether they know it or not, their decision stands on solid footing. The industry sectors and the S&P 500 index show a nearly 90% correlation when we look out five years. However, real estate stands uncorrelated from the pack… Allocating to real estate tends to lower risk and increase return.“

Yale University’s Robert Shiller, winner of the 2014 Nobel Prize in economics, goes even further, as summarized by Barron’s:

“Which asset class has performed as well as bonds during U.S. equity bear markets of the past 60 years? The answer, perhaps surprisingly, is residential real estate… Residential real estate might even be a superior hedge than bonds in the next equity bear market.”

Sure, we all know that the real estate market collapsed with the most recent bear market, now known as the Great Recession, but according to Shiller, it was caused, at least in part, by unusual developments such as “subprime mortgages, securitized in tranches, and dubious innovations, [as well as] liars loans” — variables unlikely to play a significant role in the future due to greater vigilance by market regulators.

“All of this,” says Barron’s writer Mark Hulbert, “suggests that investors should consider the possibility of hedging their equity portfolios with an allocation to residential real estate.”

We agree, and it looks like word’s getting out: according to Attom Data Solutions, the share of U.S. homes purchased by investors has hit its highest level in at least 21 years. Further:

Whether you’re from the US or the UAE, “If you are diversified among different forms of wealth, nations, and industries, you’ll be safe in the long run,” according to Sir John Templeton, the American-born British investor and Franklin Templeton fund manager. And the stats back him up.

Indeed, investing is not gambling. Warren Buffett has been right about a lot of things, but chances are he’s not right for you.

“Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas.” — Paul Samuelson, economist and the first American to win the Nobel Memorial Prize in Economic Sciences