Wise Money Decisions

This Investors Business Daily article entitled “Too Much Diversification Can Hurt You” is a good example of the kind of “throw away article” that the mainstream financial media churns out on a daily basis. 

The premise is that too much diversification can hurt you because you might pick a bunch of bad stocks.  The article gives this helpful little bit of advice:

“Research shows it’s better to own several high-quality stocks than dozens of stocks.”

Now there’s some enlightenment I can take to the bank!

For some unknown reason the article doesn’t quite come out and say it, but the implied reasoning is that you will pick bad stocks if you “diversify” and you will pick good stocks if you don’t “diversify.” 

That’s an assumption that is silly at best and harmful at worst. If you are able to pick good stocks, then you should be able to pick them whether you “diversify” or not.  Picking good stocks and diversifying are not mutually exclusive.

There may be something redeeming further down in the article. I don’t know.  I didn’t make it that far.

I find it comical that these short, silly little articles do away with decades of research into the benefits of diversification with a simple swat of their proverbial hand.

So why do these silly/harmful articles get written?  I’ll give you some options:

A) To share helpful knowledge

B) To teach people how to make money in the stock market

C) Because a journalist has a deadline and has to come up with something or he’ll lose his job

If you don’t know the answer, follow the advice I got from a friend as I walked in to take the ACT many years ago:  “Always guess C.”

Of all the skills that our government leaders should have, a basic understanding of economics is high on the list.  Too often I see politicians say or do things that betray basic misunderstandings of how the world works.

Here’s the latest example. From this AP Yahoo article about the Greek debt crisis, we have the Swedish finance minister Andres Borg saying:

“We now see herd behaviors in the markets that are really pack behaviors, wolf pack behaviors,” he said. If unchecked, “they will tear the weaker countries apart. So it is very important that we now make progress.” 

Does Mr. Borg really believe that Greece’s problems are a result of investors knowingly banding together to bring Greece down?   Really?  

Could decades of Greek financial and social mismanagement have something to do with it?

Borg’s misunderstanding is, alas, a common one.  My sense is that most people (politicians and non-politicians, and even some economists) don’t appreciate the “information aggregation” aspect of markets.  Market prices are a source of information that can help us understand what’s going on in the world. Market prices are the messenger.

For example, when the cost of milk goes up, something is causing it.  It may be a result of bad weather, mad cow disease, increased government regulation, higher consumption, or other factors.  The higher price is an effect, not a cause.  It is a message that something is going on, not necessarily that there are sinister forces conspiring to increase the price of milk (which could be a cause, but should not be the de facto explanation for any price whose level we think is too high).  If government believes that something should be done to lower the price, it should begin from the premise that the high price is telling us something.  It should figure out what that something is.

If the price of assets with Greek exposure is going down, the right conclusion to draw is that their value is low, not that speculators have banded together to punish Greece by selling assets at artificially low prices. 

By the way, if Mr. Borg’s explanation is correct, then these unidentified speculators have found a great way to lose lots and lots of money. After all they are selling at below fair price.  I only hope Mr. Borg is smart enough to take advantage of this supposed fire sale by dumping his entire net worth into Greek government bonds.

Fortunately there is another European finance minister that seems to have a better understanding:

“I’m against putting all the blame on speculation,” said Austrian Finance Minister Josef Proell. “Speculation is only successful against countries that have mismanaged their finances for years.” 

Update: Over at Seeking Alpha, Kid Dynamite offers another explanation for Greece’s problems.