Would you feel comfortable owning a portfolio that was 100% invested in a single stock? Now before you answer, what if I told you this was not just any stock, but a really good, solid company. A household name. A recognized leader. A stock that has performed well through thick and thin. A company run by sharp management and an experienced Board. A company whose stock is followed by an army of analysts. One with a proven track record of beating earnings estimates and increasing their dividend year after year. What about that kind of company?

From the description above, you might be thinking about Apple, or Amazon or perhaps Wal-Mart. These companies have all been strong performers recently. But not long ago that description would have easily applied to General Electric. For fifteen years in a row, from 1993 through 2007, General Electric could do no wrong, and was ranked the largest (or second-largest) company in the S&P 500 index. GE was also an original component of the Dow Jones Industrial Average, and a continuous member since 1907. That is, until this year when GE was kicked out of the DJIA in favor of Walgreens. From its peak in September of 2000, GE stock has fallen an astonishing 70% and now trades at about the same level it did in 1995.

The “GE experience” is one of many reasons why no prudent financial adviser would recommend a single-stock portfolio. Almost anything could happen, and there is simply no academic theory that can accurately estimate the return on a single stock, or even one that can say with any confidence that it should be positive. (In fact, most individual stocks actually do not beat the return on US short-term Treasury bills!)

So it seems obvious that a single stock portfolio is needlessly risky. But what about a portfolio that invests in a single country? Not just any country. A large, developed country with a highly educated labor force and a strong work ethic. A technologically advanced country. One with a deep, liquid stock market containing well over one thousand publicly traded stocks. A peaceful country with a strong commitment to protecting private property rights. A proven track record of economic growth and high stock returns. A country that is safe for tourists and its citizens alike. What about that kind of country?

Does this sound like the United States of today? It certainly could be, but this is also an accurate description of Japan in the late 1980’s. It’s almost quaint to recall today that during that period, it felt as though the whole world was “turning Japanese” (my apologies to The Vapors). The investor exuberance for Japanese assets in the 1980’s has few historical parallels. The Japanese stock market returned an average of 20% per year during that decade. In just five years, the Japanese stock market more than tripled in value from 1985 until its peak on December 29, 1989. It was estimated that the land value of just the Imperial Palace Gardens in Tokyo may have exceeded that of the entire state of California at that point.

From its dizzying heights, the Nikkei 225 index of Japanese stocks began falling on the very first day of trading in 1990 and has still not recovered. Nearly 29 years later, the Nikkei remains 43.8% below its 1989 peak, and Japanese investors who chose not to include other countries in their portfolios are still feeling the pain.

This anecdote is not meant to be a prediction for any single market in particular, but it does demonstrate the folly of highly concentrated portfolios. From evidence-based investing, we know that you are much more likely to have a successful investment experience if you diversify your portfolio across different securities, asset classes and by geography. The good news is that investors can easily avoid the Japanese experience depicted above with some smart portfolio engineering and today’s plethora of investment options make this easier than ever before.

 

Sources:     https://amaral.northwestern.edu/blog/how-much-was-japanese-imperial-palace-worth

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2900447

https://en.wikipedia.org/wiki/Turning_Japanese