I’ve been spending a lot of time with financial planning clients recently and discussing retirement. The discussions focused less on what my clients wanted to have in the bank at the end of their plan but focused more on how to get there. I gave them my usual spiel: how important it is to diversify asset classes and geographies.

The next step is how to diversify. Modern Portfolio Theory states that with diversification comes smoother gains but how to best diversify. Depending on the theme, geography or industry, professionals frequently use mutual funds and more and more, investors are beginning to use exchange traded funds (ETFs). Like a mutual fund, through purchase you get a basket of stocks, but unlike mutual funds, ETFs are priced and traded throughout the day.

I was reading some financial literature on Yahoo Finance when I hit upon an article: Mutual Funds are for Losers. Great title (before you get to the content) and it captured my attention.

I don’t want to get personal, but I thoroughly disagree with this article. Phil Town, advisor and author, has recently published a book “Rule #1,” that amounts to: “Don’t lose money, find great companies, know their worth and acquire them at 50 percent off. Beyond that, he says the traditional advice — invest in mutual funds, diversify, buy and hold — is strictly for losers.”

Well, it may sell books but his advice is off the mark. I’m all for buying companies at a good value but what does 50% off mean? Off of what? Trying to buy companies at huge discounts to their book value doesn’t happen much these days. Instead investors have to find different ways of assessing value (see Magic Formula Investing) at more modern valuations. In this article, Town doesn’t define what “on sale” means. That’s important. How is my father supposed to know what to do with that information?

But what really struck me was the author’s contention that investors would be better served by buying a couple of good companies and just sitting on them. While I agree that to maximize the potential for hitting an investment homerun, concentrated bets are the only way to have huge returns — the problem is, for must of us (including professionals), there is only one Warren Buffett. What if my analysis isn’t correct or there is a huge credit crunch which no one — I mean no one — aptly predicted to occur to some of the US’s best banks (Merrill Lynch, Citigroup, et al.) What if Johnson and Johnson (one company Town names by name in the article) has a factory blow up in New Jersey? Or that Exxon Mobi, previously one of the world’s largest firms, is supplanted by PetroChina, the world’s first $ trillion company? Taking concentrated single-stock picks is really risky.

I’d like to posit that instead of swinging for the fences, something responsible advisors would never advise to do, most investors ARE best served by diversifying though mutual funds and ETFs. With the US dollar falling and investors wondering what to do next with their retirement dollar-denominated nest eggs, diversification is the only way to go. I don’t mind paying management fees (something Town discourages) if I get something in return. Sometimes its geographical exposure I can’t get with a passive indexed ETF. Sometimes, its active management of bond portfolios (something that ETFs don’t really capture.)

Do your homework and don’t follow every new author who publishes a book contradicting decades of financial and academic research.

[Image source: AntiGallery on flickr]