Are you diversified?

All of you have seen Jim Cramer's, Mad Money, in particular the segment when a caller call in and tells Jim the stocks in his/her portfolio and Jim goes on about how well concentrated or diversified he/she is. While the intentions are good the reality is that in general a given stock's movement is largely described by the overall movement in the broad indexes (s&P 500, DJ-30, etc.). Throw in some volatility or beta, and your position is just collateral from the general buying or selling fever of the day. In my opinion, diversification in the traditional sense is a devise created by brokers to cover their ass and ensure their clients will preform just as mediocre as everyone else and will provide you roughly what the general markets gives. Investopedia provides a good article on the danger of over diversification. This article suggests an optimum number of stocks to own to ensure diversification is about 20. I agree with some reservation. Based on the Modern Portfolio Theory, holding 20 positions will eliminate unsystematic risk, or the risk associated with holding an individual position. The theory goes on to state that systematic risk can not be diversified away. Therefore, if you are in the stock market and it crashes your positions will crash as well. This gets very close to smelling like on a risk adjusted level you will have a difficult time "beating" the averages.

This brings me to the real point of this story. Maybe the new model should be based on something like the Harvard Endowment which has handedly beat the market for years. The model used by Harvard is to diversify across asset classes (domestic and international stocks, bonds, real estate, private equity, hedge funds, commodities, etc.). I would suspect this approach has not gained much traction for the general population because of the lack of vehicles available to invest in, that is until recently. Money Magazine's article on Ivy League investing sheds some light on what makes these endowments tick.

These graphs demonstrate a new frontier of diversification and how the individual investor can emulate the big boys portfolio.

***Before taking on any new or otherwise investment strategy talk to your financial adivsor to discuss your particular risks and objectives.***