By Tom Bradley

I got an email from Neil on Saturday afternoon:

From: njensen@steadyhand.com
Subject: Words of wisdom from Swensen
Body: Read while watching Claire at swimming today (p.60): "Sensible investors pursue diversification as a policy to reduce risk, not as a tactic to chase performance."

Upon reading his note, my first thought was 'Are we warped or what?' Even our tech/ops guy is reading Swensen (the author of Unconventional Success, which is at the top of our recommended reading list) while watching his daughter at swimming lessons. Whoa!

In reality, Neil is an excellent investor (after all, he’s been hanging around PH&N and Steadyhand for 10 years) and his Swensen quote is right on.

The next line after Neil’s quote on page 60 reads: “By following a disciplined policy of maintaining a well-diversified set of portfolio exposures, regardless of market zigs and zags, investors establish the conditions for long-run success.” I take away three things from these comments.

First of all, it’s a reminder that diversification is the only ‘free lunch’ we have available to us. In other words, by properly diversifying, we can lower the volatility and capital risk of our portfolios without reducing long-term returns.

Second, we should not confuse diversification with market timing. A properly diversified portfolio will lead to success in the long run, but it is totally random as to whether it helps returns in the near term. We should not judge the success of such a strategy based on short-term results.

And third, a disciplined diversification strategy (i.e. unemotional, automatic re-balancing) increases the odds that you will add to asset classes after they have done poorly rather than chasing them after they’ve done well.

Thanks for the note Neil. Keep swimming Claire.