Diversification is everyone's favorite topic in the world of personal finance. Too bad it's so often misunderstood and watered down. Today's episode is all about why you, as an individual, cannot replicate what an institutional money manager does. And this discussion goes far beyond just selecting investments.
Why not just go out on your own? You don't really need to pay all those fees to “professionals”. All the information you would ever need is at your disposal for you to be a great do-it-yourself investor.
But this is a huge fallacy. Why doesn't it work?
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You and I as individuals just don't have access to the same markets that institutional investors have. And honestly, their is a reason that a great deal of institutional investing happens in a different way.
A Chain Reaction
The major reason is that a an institutional investor can place a trade so large that it could cause artificial inflation in the price of a stock if the order were processed on the open market.
This sort of trade could set off a chain reaction of unintended consequences that hurts everyone who owns a stock (as an example).
But the biggest difference that we want to zero in on, is from a risk perspective. We think most people oversimplify risk far too often and we want to add a bit to your perspective on the subject.
How Should You View Risk?
You have to understand that when you entrust your money to institutional manager, whether it be someone invests in stocks, bonds, or even a life insurance company that holds your cash value, you are taking advantage of scale that you would never be able to replicate.
They can diversify by hiring different people to handle what they would be tiny fractions of the money (you know what's a couple hundred million between friends) and those people may work for different companies and in different parts of the world.
For example, a life insurance company may have an entire team that manages commercial estate assets focused on the retail sector and have another manager who oversees their aircraft leasing operations. Yes, they own commercial airliners that they lease to the airlines.
There is a team or team of teams that have very specific roles and are specialists in their fields. That's the sort of scale and diversification you and I could never achieve on our own.
