Learning from big boys' losses

Word came out the other day that Warren Buffet had lost $1 billion investing in foreign currency (betting against the dollar), and that Robert Rubin, our former treasury secretary, had lost a million dollars making the same bet.

What is it with these guys? They both have genius-level IQs when it comes to investing money. Rubin was the head of the Goldman Sachs trading department, and he eventually ran the entire company. Now, in an effort to end this unpleasantness, he is struggling to unwind his position. Buffet used to walk on water, and now he's under water with respect to this particular investment.

David Leonhardt explores these bad calls in an interview with Rubin in the Nov. 1 New York Times. Buffet talks about his problem in his famous letter that is part of the Berkshire Hathaway Annual report for 2005.

For me, the silver lining in this sorry episode of two poor guys losing so much money is that there has to be a lesson here for the rest of us.

The lesson may be that our educated guesses regarding the future returns of any single investment type or strategy can be woefully unrewarding. Just when we think we have a reasonably justifiable glimpse into the future, we learn that the matrix of influences is just too vast to weigh all of the component parts.

Timing the stock market, we should know by now, is impossible. But timing any market, even one as select as foreign currencies, can frustrate even the smartest investors on the planet.

Investing for retirement faces the daunting challenge of making decent investment returns without having to lie awake at night.

A billion-dollar loss is just "chump change" for a legend like Buffet, but single bets for real people like us could be a disaster. Many learned this lesson in the 1990s, when investing in a variety of tech stocks and tech mutual funds left people thinking that they were diversified.

Real diversification occurs when we have a broad selection of mutual funds that are inversely correlated. By this, we mean that one fund will have a tendency to go up when another fund is dropping in value.

The mutual fund industry, just within the past year, has discovered what is called "multiple-asset-class" investing -- or "the next big thing." Within one fund, they have erected what I would call "silos" that invest typically in five different asset classes.

To take a specific example, we can look at MFS fund's Diversified Income Fund. This fund is investing in the following portions of U.S. government debt (20 percent), high-yield bonds (25 percent), emerging market debt (15 percent), value stocks (20 percent) and REITs (20 percent).The money is rebalanced on a monthly basis.

Readers of this column may find themselves thinking that the concept sounds vaguely familiar. We have been advocating for years that a mix of investment types that differ fundamentally from each other will generate gratifying and less volatile returns than any other approach to investing.

This approach even generates better results than the so-called "lifestyle" funds that are growing in popularity. The latter just offer some mix of bonds and stocks that shift progressively toward bonds as retirement age approaches. Some companies use just a mix of bond index and stock index funds to do the job and then add one full percentage point to the expense ratio for the "package."

Saving the 1 percent, a prudent investor might consider the same basic concept but choose their own funds from an unlimited selection of top performers with low costs (even index funds) to represent each fund type.

To their credit, the fee-only financial planning community tends to perform this service for those less inclined to want to do the research and rebalancing themselves.

As for Buffet, the billion-dollar loss could be viewed as an insurance premium of sorts. We pay premiums all the time to protect against losses, and if we don't have the loss, the premium money is gone forever. He may have paid a big premium, but he still enjoys some protection against a falling dollar.

Elsewhere in Berkshire Hathaway, meanwhile, there is diversification and inverse correlation galore, so Buffet, whose stock has doubled in five years, is certainly not losing any sleep.