The northern part of the Yucatán peninsula is a very interesting place. I was surprised to find out that the Mayan language is still spoken by over 6 million people in the area. I would have guessed it would have mostly died out given that the Mayan civilization peaked sometime before 900 AD. To my ear, it is a very pleasing-sounding language and one that has a very long history. Geologically speaking, the northern Yucatán is monolithic, that is made of “one rock.” If you like limestone, you will love the place, because that’s all you get there. The entire area is one huge slab of limestone gently sloping downward into the sea. No granite, no sandstone, no gneiss, no metal ores – only limestone.
A couple of other notable features follow this unusual bedrock. First, there are no above ground rivers in the area. The only water available is underground. Second, there is almost no soil; our guides suggested that only a few inches of soil is available in most areas. To think that the Mayans built one of the most sophisticated civilizations in the world to that time, much of it on this harsh slab of rock, boggles the mind.
While at the seacoast ruins of Tulum we learned about a clever adaptation Mayan famers implemented in the shallow soil there. They would plant in the same patch of land maize (corn), beans and squash. The corn stalks would provide a natural trellis upon which the bean plants could grow and flourish while the squash would cover the remaining bit of ground with their leaves and fruit. Thus they could grow and harvest three different and complimentary crops in the same area – all three would grow and thrive in that thin soil.
For some reason, this discussion got me thinking about equity investing. As I pondered the question why three crops in one plot of ground were better than just one, I saw the parallel to an equity portfolio – three stocks are better than one. Let me explain. The best performing stock in the Down Jones Industrial Average is Boeing (BA), which is up about 30% so far this year. Anyone who had Boeing and only Boeing in their portfolio this year would be very happy. But would that person realize that a portfolio which contains only Boeing represents the riskiest portfolio possible? Risky? “Poppycock!” you might say, “there’s no risk, the stock is UP!”
Alas, here is one of the great misunderstandings in the field of investing – risk is not the same as losing money. Risk is a measure of volatility; losing money is what happens when prices go down. One can have a diversified portfolio and still lose money. Yet, the probability of seeing wide fluctuations in returns rises the fewer stocks one has in the portfolio.
The key here is what the pros call “systemic risk” and “non-systemic risk.” Systemic risk is the risk we all share by the fact that we own stocks. The market’s movements and volatility impacts our portfolio to a sizable amount. There’s not much we can do to lessen this kind of risk. Non-systemic risk comes from the stocks we own in our portfolio. Each stock has a unique risk profile that will affect our portfolio based on its own volatility. Mathematically, a single stock portfolio has the maximum amount of non-systemic risk (regardless of the return in any holding period). As if by magic, simply adding another stock (assuming its risk profile is not identical to the first one) will reduce the portfolio’s overall risk profile. Adding another one will help some more. Studies have shown that owning about 30 stocks is the optimal way to reduce non-systemic risk to something close to zero.
Perhaps the ancient Mayans would have been astute investors – they seemed to be pretty good at everything else. I suspect they would have understood the merits of portfolio diversification and invested accordingly…
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