What’s Your Attitude To Investment Risk?

Here’s some good news from Bloomberg:

Australia’s economy grew faster than forecast in the final three months of last year, driven by a plunge in household savings to the lowest since 2008 and increased home building underpinned by record-low interest rates.

Hoorah!

Savings down. Borrowing up.

What could possibly go wrong with that…?

Forget the doom and gloom, just buy stocks. That seems to be the message the market is giving you, anyway…

The destructiveness of diversification

As for our thoughts on that, we wouldn’t be so sure that’s the right thing to do — not across the board, anyway.

But, as we’ve often explained, we’re not in favour of following the crowd, or in following conventional investment advice.

We believe that investors should still own stocks — even though we issued a major crash warning last August. The reason is that we still believe that stocks are one of the best ways to build long term wealth.

The only better way is by starting, or running, your own successful business. But that’s risky too. Statistics show that most new businesses fail within the first three years.

So to avoid putting all your capital — and all your risks — ‘in one basket’. Stocks are a good way to spread some of your risk.

Our one piece of advice on that is to not over-diversify.

As famed hedge fund manager Stan Druckenmiller told attendees at the Grants Interest Rate Observer Fall Conference last October:

I think that diversification is the most destructive, overrated concept in our business. I am a put-all-you-eggs-in-one-basket-and-watch-the-basket-very-carefully kind of investor. If you look at George Soros, Carl Icahn, Warren Buffett, what do they all have in common? They make huge, concentrated investments. They don’t spread their money all over the place.

I agree with Druckenmiller. Diversification is overrated. We can show you why.

Check out this chart:

Source: BloombergClick to enlarge

From the peak in 2007, to the trough in 2009, the diversified S&P/ASX 200 index fell around 52%.

In other words, if you owned a diversified portfolio of stocks, you would have lost half your money. So much for diversification.

But if you follow Druckenmiller’s advice, buying just a handful of stocks, backing them, and then watching them closely, you’ve got a 50% chance of beating the index.

Of course, you’ve got a 50% chance of doing worse than the index too.

Remember, an index, like the S&P/ASX 200, is an average of stock performance. Like all averages, it means that some stocks did better than the average, and some did worse.

This isn’t rocket science; it’s basic math.

That’s why we don’t pay much attention to the mainstream idea of stock diversification. Instead, we’re more inclined to believe in asset diversification and allocation.

We say that investors should have some of their money in stocks, some in cash, some in gold and silver, and some in other assets. That could be property, collectibles, or alternative investments, such as wine or vintage cars.

It all comes down to the individual investor’s personal preferences, attitude to risk, and requirement for returns.

Let’s say you had a liberal attitude to risk — you’re fine taking risks as long as there is potential for big gains. Although, you also understand that the losses can be big too.

Where could you look right now?

One area that always seems to offer interesting and illuminating opportunities is technology. Check this out…

It’s coming

Our resident tech expert, Sam Volkering, flipped this email to me this morning from London:

The major talking point across every major news channel (BBC, Sky News, Aljazeera, RT, CNBC, Bloomberg, etc.) is that Google’s self-driving car collided with a bus yesterday.

It’s amazing how just one car accident is global news, when millions of people die on the road every year and no one bats an eyelid. Yet a self-driving car has a minor accident, and pessimists jump all over this claiming the technology simply isn’t safe.

Let’s not go crazy here, the ‘crash’ was at 3km/h and no one was injured. But, most importantly, Google’s self-driving cars now know that buses are unlikely to yield like normal vehicles in that situation. Imagine that — a minor accident and then an entire fleet of cars get an over-the-air update to say, ‘hey, don’t do this in this situation’, and then it never happens again, ever.

That’s the power of self-driving cars. They can learn and then become better, smarter and safer.

What else this ‘media mania’ tells me about self-driving cars is that they’re going to cause mass disruption to society. It’s like going from the horse and cart to the first cars, from candles to electricity, and from no internet to the internet.

It’s a dramatic shift in mobility and it’s going to reshape our society to be safer, more efficient and lift our overall standards of living. It’s the single biggest change in society of the 21st century — and the single biggest opportunity for investors.

Sam makes a good point. And to all those ads from the TAC saying that they’re aiming for a zero road toll, we blow a raspberry to tell them it’s not possible.

In fact, if we’re honest, it amazes us that there aren’t more accidents on the roads. Think about it, cars, buses and trucks whiz past each other at speeds of up to 80km/h on suburban roads, and faster still on freeways and highways.

These vehicles pass within centimetres of each other and, yet, comparatively few people die on the roads each year. It’s a marvel of human ability to drive, judge speeds and distances, and also of technology, which is making the driving experience even safer each year.

And now, if self-driving cars take off to the extent that some predict, the roads could be even safer. Maybe the TAC will eventually get its zero road toll after all.

But this kind of scaremongering in the mainstream is typical of most new technologies.

If something is wildly outside the norm of expectations, people fear it. Perhaps that’s a genetic thing — flight or fight.

This is where investors need to look at the opportunities. They need to look past the odd looking self-driving ‘bubble cars’ and think about how this technology could develop in the future.

Take electric cars as an example. It wasn’t so long ago that car manufacturers insisted on making electric cars look, well, stupid. Then along came innovative carmaker, Tesla Motors Inc. [NASDAQ:TSLA].

It showed the industry that electric cars don’t have to look so odd…that they can actually look like a normal car. Now, Tesla, in terms of its annual production, is still a small company.

And despite the fanfare over its product, the jury is still out on whether the company will ever live up to the hype. But forget about that for a minute, and just look at the stock price:

Source: BloombergClick to enlarge

It’s up 996% over the US$17 IPO price in 2010.

Compare that to a 9.2% loss for Ford Motor Company [NYSE:F], and a 7.4% loss for General Motors Company [NYSE:GM] over the same timeframe.

GM and Ford produce significantly more cars than Tesla, but they don’t currently have the same cachet as Tesla.

As we see it, where the electric car industry is today is where the self-driving car industry will be in the not-too-distant future.

We’re not saying companies in the industry will be profitable, or even that it will catch on with the mass market straight away. But, at the very least, it won’t be long before self-driving cars move from novelty value into an industry that the market will have to take seriously.

Cheers,

Kris Sayce,

Publisher, Money Morning

From the Port Phillip Publishing Library

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Money Morning is Australia’s most outspoken financial news service. Your Money Morning editorial team are not afraid to tell it like it is. From calling out politicians to taking on the housing industry, our aim is to cut through the hype and BS to help you make sense of the stories that make a difference to your wealth. Whether you agree with us or not, you’ll find our common-sense, thought provoking arguments well worth a read.

Money Morning Australia is published by Port Phillip Publishing, an independent financial publisher based in Melbourne, Australia. As an Australian financial services license holder we are subject to the regulations and laws of Corporations Act and Financial Services Act.


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