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Free Lunch

September 15, 2017

"Tis the part of a wise man to keep himself today for tomorrow, and not venture all his eggs in one basket."

- Don Quixote

TAKEAWAY OF THE WEEK

Basic economic theory dictates that there’s no such thing as a free lunch. Nobel prize-winning economist Markowitz begged to differ – he called diversification “the only free lunch in finance.” But he wasn’t the first to understand the benefits of diversification – long before he came up with the Modern Portfolio Theory in 1952, Shakespeare’s Antonio in Merchant of Venice already eloquently expressed his understanding of the concept:

Believe me, no. I thank my fortune for it —
My ventures are not in one bottom trusted,
Nor to one place, nor is my whole estate
Upon the fortune of this present year.
Therefore my merchandise makes me not sad

Markowitz’s theory is if you hold a portfolio of investments that are not perfectly correlated, an investor can lower risk without sacrificing expected returns. Simply put, spreading your investments across asset classes and geographies gets you the same reward with less risk = free lunch! 

Diversification is not particularly exciting, but it reduces the risk of blow-ups due to any single investment. A diversified portfolio will always have a few investments that are not doing so well, a few that are average, and hopefully a few that do great. The thing is – this is random and beyond our control, but if we are diversified, on average we will do just fine. As you can see from the table below of the top ten performing asset classes per year, there is no predictable pattern.

Read more: Why Global Asset Allocation Still Makes Sense (IMCA)

Diversification takes time to work – and we are talking years and decades, not weeks or months. There will be times when you wonder why you didn’t just put all your money in Amazon shares, but the value of diversification needs to be judged over years. There aren’t many things we are sure about in life, but one thing we do know is that over the long term, diversification allows you to weather even the worst of storms.

THE WORLD IN VIEW

Business

143 million people hacked (New York Times)

Whole Foods Is Becoming Amazon’s Brick-and-Mortar Pricing Lab (Harvard Business Review) 

Tesla intentionally makes some of its cars worse, and it’s good for everybody (Quartz)

Markets

Bitcoins are "worse than tulip bulbs" - Jamie Dimon (Bloomberg)

A savings account that pays >2.5x more if Manchester United 'do the double' (Telegraph)

2,000 years of economic history in one chart (Visual Capitalist // below)

Singapore

Who is Halimah Yacob, Singapore's first female President? (Channel News Asia)

And she lives in an HDB (Straits Times)

Longform

Plunging into Saturn after 20 years of space travel (The New Yorker)

Podcast

Jenn Hyman on how she built Rent the Runway (NPR // 57 mins)

Good To Know

If a monkey takes a selfie, does the monkey own the photo?  (New York Times)

Killer sex robots (New York Post)