Things my pappy told me about bear markets (part 2 of a series)

Written 2023-05-03 - “The Ike Street Journal – the weekly diary of the American nightmare”

Warning: None of the following is investment advice. Do your own research and make your own decisions!

The jumping off point for my rant this week is the touchy topic of diversification (buying a larger number of investments vs. concentrating in the few you like the best). This is a surprisingly contentious subject among investing pros, in spite of the established fact that there have been very successful investors of both the anti-diversifying (Buffett/Munger) and diversifying (Schloss) persuasion.

In this dispute, I have to say the anti-diversifying/pro-concentrating side tends to be more obnoxious – some advocates like Munger dismiss diversification as a training wheels form of investing, needed only by those who don’t really know what they’re doing. Perhaps the most vivid expression of this I’ve heard is by one hedge fund manager who was known to say “If you own more than four stocks, you’re just jerking off.”

My own view is boringly middle-of-the-road – I think it’s clear from the record that either diversifying or concentrating can work. So, here are my boring thoughts on how to choose which to do.

In general I think there are many approaches that can work in investing, but with an important requirement – whichever approach you pick, you have to be very comfortable with it. This is because humans are social animals – we are strongly wired to be influenced by the actions and opinions of other people – and, in investing, you often have to work against that tendency.

For example, suppose you invest in something and it promptly drops 15%. This happens to stocks all the time for no particular reason – there’s a lot of random noise in short term stock movements. So, the right thing to do is check whether there’s any reason for the drop, and, if not, buy more. However, if you’re not very comfortable with your investing approach this will be hard to do. You’re likely to start doubting your investment – and thus sell when you should be buying – or, at best, stand pat while experiencing some stress.

So given that it’s important to be comfortable with your investing approach, how do you decide if you’re comfortable diversifying vs. concentrating? I propose a psychological spectrum that (based on my experience watching movies) I call the American vs. European outlook on life. Consider a typical American movie. You can generally be confident that, while there may be some obstacles along the way, the hero and heroine, after some heroic efforts, will wind up happily together. By contrast, if it’s a European movie you can anticipate with some confidence that things will not end well (additionally, if it’s a French movie, one of the main characters is likely to abruptly commit suicide in the last 5 minutes).

In other words, the dichotomy here is the belief that you’re in control of your destiny, vs. that Fate is in control – and, I think there is a real cultural divergence here (an interesting variation is stoicism, which I think of as a useful version of the European outlook – you can’t control your destiny, but you can control your reaction to it).

My purpose here isn’t to argue for the American or European outlook, but to point out that we tend to absorb one or the other as we grow up, and it’s very difficult to change once we’re adults. I also suggest that your outlook will predict how comfortable you are with concentration – those with a more European outlook will fundamentally be less comfortable with concentration in only a few investments. This is because if you have a European outlook, then you’ll likely believe that no matter how thoroughly and well you do your work on any individual investment, it still might blow up – and, if you’re concentrated, thereby blow a large hole in your portfolio. (Note that if you have an American outlook you still might decide to play it safer and diversify, but I think you’ll have more of a capacity to go the concentrated route if you choose).

In my case, in spite of growing up in America, I feel my outlook is more European – I blame the fact that my parents and their friends were mostly European refugees, so the people I experienced growing up had a strongly European outlook.

Addendum: A friend, after reading the above, sent me the following article. I was pleased, if kind of shocked, to discover that there’s some actual hard data backing up my idle speculations:

In a 2014 survey, 57% of Americans disagreed with the statement “Success in life is pretty much determined by forces outside our control,” a higher percentage than in any of the European nations polled.

https://www.pewresearch.org/short-reads/2016/04/19/5-ways-americans-and-europeans-are-different/