Why is it important for most investors to hold a diversified portfolio?

I often write answers on Quora, where I am the most viewed writer for investing, wealth and personal finance, with over 244 million views in the last few years.

On the answers below, taken from my online Quora answers, I focus on a range of topics including:

  • Why is it important for most investors to hold a diversified portfolio? Or is the question wrong in itself? Perhaps diversification isn’t the be all and end all?
  • Bill Gates didn’t complete his college degree but ended up successful. Is there a broader meaning here?
  • Considering most wealthy people are older, is hard work overrated?
  • is being a movie star really glamorous?
  • Why do some successful people imply that making money is easy?

Some of the links and videos referred to might only be available on the original answers.

If you want me to answer any questions on Quora or YouTube, or you are looking to invest, don’t hesitate to contact me, email (advice@adamfayed.com) or use the WhatsApp function below.

Why is it important for most investors to hold a diversified portfolio and how do they achieve a diversified portfolio?

Source: Quora

It actually isn’t as important as people think. At least if you are young or relatively young and invest sensibly.

Let me give you an example. Stocks have always beaten bonds long-term. There has never been a time when bonds have beaten stocks over a lifetime.

As per the graph below, this makes a huge difference long-term:

In addition to that, you can get access to stocks without putting all your eggs in one big company like Amazon.

You can buy the S&P500 which is already diversified in terms of industries, and indeed globally, as per the below:

If you buy the S&P500, or for that matter MSCI World, you are buying a bit of every industry and indeed country in the world.

Apple, as one example of many, isn’t really an American company anymore. Most of their revenues is in foreign countries, and therefore in foreign countries:

Given these factors, it is unsurprising that the S&P500 has never been down over a 30-year period.

I am not saying somebody should be 100% in an asset like the S&P500 forever.

I do believe that bonds, and some other assets, can play a role in a portfolio, especially as you get older.

But rationally speaking it is good to have two stages in your wealth journey:

  • The wealth accumulation phase. The aggressive stage in your 20s, 30s and maybe 40s. At this stage it makes sense to put 90%-100% in stock indexes . It doesn’t matter if markets fall. They will recover. If they take 10 years to recover in a crash then great, you are buying cheap for an extended period of time!
  • At the preservation stage, ideally 10 years before retirement, focus on wide diversification.

The bottom line is, having some diversification is important. You don’t want to be in one or two stocks.

Buying a broadly diversified stock index like the S&P500 makes sense as well. Yet being broadly diversified across asset classes isn’t usually needed for people who are relatively young.

Study after study has shown that broadly diversified portfolios are just less volatile than more concentrated ones. They underperform long-term.

Achieving it is easy. You can either invest by yourself, or through an advisor.

If annuities are thought to be such a bad investment, why do so many invest money in them?

Source: Quora

There are many types of annuities, with corresponding risk levels, as per the above

There are many types of annuities, with corresponding risk levels, as per the above.

In any case, you are right that pretty much all annuities don’t offer great value, so many people ask why so many people still buy them.

For me, one of the main reasons is the perceived security/certainty, together with simplicity.

Ultimately, annuities pay out a fixed return. Some annuities are inflation-linked and some aren’t.

Either way, most pay out a monthly income, which many people got accustomed to during their working lives.

There is no such thing as a free lunch. Therefore, if a financial company is willing to “buy out” your investment (including pension) for a fixed income, that is because they have done the maths.

The maths tells them that based on the amount of money the book is worth, they can make a profit on it, adjusted for how many years the person is likely to be alive for.

Added to that, many annuities aren’t paid to the account holders beneficiaries like kids, once they die.

So, usually annuities die with you.

That means that even if the financial company doesn’t make more money from the pot whilst you are alive, it might still be profitable to buy out the book.

It also means that the person retiring can’t pass on a portion of their investment to their kids.

Studies are clear. Drawdown is usually better than annuities. The only way it isn’t better is if financial markets underperform.

In which case, you are left with an income greater than you would have achieved through an annuity.

Annuities aren’t automatically less risky either, as inflation can erode them.

So in reality, emotionally security is the main reason for many to buy annuities.

That doesn’t mean annuities are “a scam” though. Some cheaper ones aren’t always dramatically worse than drawdown, and people buying them usually know the score.

It is common sense. The person buying the book needs to get compensated for taking on the risk of paying out a fixed income.

How did Bill Gates learn to run a business so successful without a formal business education?

Source: Quora

Think about the industry you are in. Or your friends, family and associates. Would a 14, 16, 18 or 20-year-old be offered big projects?

I am guessing the answer is a resounding no, no matter how talented they are, unless it is a new industry where few older people have the skills.

Bill Gates was good at a different time.

He had skills and experiences which 99.999% or more of adults didn’t have, in an up and coming area, which was becoming big.

Therefore, he was called upon at a very young age, to do difficult projects. It was an Outlier situation which is spoken about in this book:

If Gates was born in 1900, 1980, 1990 or 2000, he wouldn’t have achieved what he did.

If he was born today, he would probably become a multimillionaire but not one of the richest people ever.

That doesn’t mean he isn’t incredibly smart and, unlike many, he fully took advantage of this opportunity.

Most people don’t. In fact, so many people have squandered bigger opportunities than he got.

Yet just because Gates made it big from a young age, and without much formal experience at a company, doesn’t mean most will.

The statistics are clear. People with more experience are much more likely to achieve business success than those without.

That is because with more experience you have more contacts, skills, clients and sometimes money.

Getting a job first, getting good at it for five or more years, and then starting alone, is the most tried and tested route.

The only exception to this rule is that it is easier to make it big in a completely new industry, or a developing country, where there is less competition.

Education can be important, but isn’t as vital as having experience in a chosen field.

Also, he did have a formal education, and got admitted into Harvard. It wasn’t like he left school at 15 or 16.

He just didn’t complete the course.

Who really believes that movie stars and celebrities have better lives because they’re rich and famous?

Source: Quora

Probably people who have never been there, or met anybody who has. This quote says it all:

Unlike what some people might believe, there is a correlation between more money and happiness + less anxiety.

Yet that doesn’t mean all people who have more money are happier. Plenty aren’t.

I suspect that many celebrities aren’t because if they are very famous they need to deal with:

  • Intrusions into their private lives
  • Sometimes family members get harassed by the press.
  • Vicious social media trolls
  • More security concerns
  • More hangers on looking for hand outs including old “friends” from school who come out of the woodwork
  • Insecurities that as they age, they will get fewer parts, and therefore the pressure to make cosmetic changes must be high.
  • More scrutiny in general. So, if they have business interests, and they are late on taxes, it is more likely it will get published.
  • More job insecurity unless they are very famous. Fame is shallow. It comes and goes. Think about some A-listers from the 90s! Many are nobody’s today.

Added to this, plenty need to deal with this as young, and relatively young, people.

Most 20 or 25-year-olds care much more about what people think, so get affected by this kind of thing.

No wonder, then, that many celebrities have addiction problems, and often become broke financially, despite earning a lot.

Being wealthy and close to anonymous is far better. For this reason, I imagine that C listers are happier than the average A lister.

The same thing, I think, applies to business people. The business person who makes $1m a year, and has a net worth of say $10m, doesn’t have to go through the same hassles as somebody who is so rich that they become famous.

Probably younger people are more likely to believe this, but it is changing due to YouTube and other resources.

It is now full of resources, including interviews with celebrities, speaking about the reality, which includes mental health difficulties for many of the people involved

In the TV age it was easier to glamorous the industry, and skip over some negative aspects.

Age and wealth are strongly correlated, yet people continue to associate money with hard work. The frail elderly are the wealthiest. People say hard work earns money, but does it? It would seem that hard work is a mere virtue and not a way to riches.

Source: Quora

Age and wealth are correlated to a much larger extent than age and earnings/wages/income.

Let’s look at a simple example – the higher flyer. He/she comes out of university and gets one of the best graduate jobs in Silicon Valley or Wall Street/City of London.

Maybe they work for some of the biggest tech, financial, consulting or legal firms.

Six figures total compensation is achieved quite quickly. $250,000, Euros or Pounds comes next and it only increases from there.

This person will likely not become a millionaire in terms of assets under 30, despite being in the top 1% for their generation.

The reason is simple. They have 0 at age 21–22 unless they have inherited wealth.

Now for the first few years, after-tax compensation won’t hit six figures, only before tax will.

Then there is rent, bills and due to the stress, an element of overspending even if you are frugal.

So let’s say from ages 21–26, on average they save and invest $50,000 a year.

Even if that hits $100,000 from 26 to 30, and the investment returns are good, the best case (realistic) scenario is millionaire status by 30, although exceptions exist.

In comparison, a person who invests just $500 a month from their early 20s until 65, will be worth about $6m upon retirement, if the past performance of the stock market is replicated.

That isn’t guaranteed, yet it illustrates an important point. The high-flyer has much more income than the second person, yet 1/6 of their wealth at a younger age.

Wealth is achieved through compounded investment returns and long-term behaviour.

Only somebody with an incredibly high income, often achieved through a setup which achieves outlier success, in addition to great spending and investment habits can become a multi-millionaire in their 20s.

So, you are right that hard work isn’t the only component to wealth. Playing the long game/leveraging time, good spending and investment habits all play a role.

Hard work, however, does play a role as well, as does conscientiousness more generally.

Those “frail old people” were more likely to be hard-working younger people.

People who are not conscientiousness are more likely to think “what’s the point in being wealthy at 40 never mind 70”, when they are 20.

Then one day they wake up as a 30-year-old and realize time passes by more quickly than expected, and regret it.

making money as though it’s a piece of cake. They tell me “learn a skill then sell it. What is difficult about that?” If it is that simple why do so many people struggle in life?

Why do most financially successful people I know talk about making money as though it’s a piece of cake. They tell me “learn a skill then sell it. What is difficult about that?” If it is that simple why do so many people struggle in life?

Source: Quora

It could just be the successful people you have met. Many successful people understand two concepts:

  • Making a lot of money isn’t easy unless you had loads of inheritance as a kid
  • Over-performance doesn’t always last. This is something many successful 20 something’s don’t get. It seems easy to make money for a time, but that doesn’t mean it will last forever. Think about things like the sports you watch. The best performing managers and players eventually don’t perform. Most anyway. There is a mean reversion. The same thing can happen in business.

With that being said, what is true is that as you get more, you get more opportunities.

That is one reason why inequality can go up even in very fair systems. Everybody wants to interview the successful business person, sports star etc.

You don’t have to knock down the door for opportunities any more, but if somebody becomes complacent, that doesn’t last forever.

Pained by financial indecision? Want to invest with Adam?

Financial Planner - Adam Fayed

Adam is an internationally recognised author on financial matters, with over 244 million answers views on Quora.com and a widely sold book on Amazon

Further Reading 

The article below focused on the following topics:

  • Is home ownership realistic for most millennials? Should it be considered desirable to begin with?
  • Should I buy or enter a stock when it’s up, still increasing, or when it’s down? I respond in detail to this one
  • What’s the best country to retire on $600 a month? Is it even possible to live comfortably on that amount of money?
  • Will China become old before it is rich and fail to catch the US?

To read more click below 

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