Good diversification is a staple of financial planning advice, though the principle long pre-dates financial planners. From the aphorism “don’t put all your eggs in one basket”, to Talmudic texts from 3,000 years ago directing people to split their wealth evenly between cash, real estate, and business, the virtue of limiting exposure to risk from diversification is an “accepted truth”.
Except the reality is that, when you look to those who achieve the greatest wealth or have the greatest impact, virtually none of them ever diversify… or at least, not throughout most of their years. After all, if Bill Gates had “just” diversified into the S&P 500 after Microsoft IPO’ed, he’d have barely 1/40th of the wealth he does today. In fact, most of those on the list of the richest billionaires are people in their 60s, 70s, or 80s, who have held a concentrated interest in their businesses for nearly their entire lives. Like the redwood tree, they waited a very, very long time before branching out… and as a result, were able to grow the tallest.
Of course, that doesn’t mean that diversification is always bad. Most “trees” are actually short bushes and shrubs, that grow just a few feet tall, but are still able to broaden their shoots and leaves enough to grow healthy. In the investing context, it’s the equivalent of a person who diligently saves and invests in a portfolio for decades, and retires with “comfortable wealth”.
Still, it’s important to recognize that diversification isn’t literally always the winning strategy, and for those who are young and have a long time horizon, arguably not even a necessary one. In fact, the weakest tree is the Bradford Pear – known for growing a V-shaped trunk, effectively diversifying itself from the start… in a manner that virtually ensures the tree will eventually either collapse under its own weight, or succumb to external forces.
For those who have decided they have “enough”, the satisficing strategy of the bush may be just fine. But for those who decidedly want to generate more wealth or have more impact, perhaps the redwood strategy is underrated after all? In fact, the highest-risk losing strategy may actually be the pear tree strategy of trying to have it both ways at once!
Redwoods, Pear Trees, and Bushes
The tallest trees in the world are Redwood Sequoia trees, with a typical height of more than 300 feet. New redwood sprouts can grow as much as 7.5 feet in a single growing season, although ultimately the oldest ones are estimated to have been around for 1,200+ years. The tallest known redwood, dubbed “Hyperion”, is a whopping 379 feet tall, and is believed to be more than 600 years old. And most mature redwoods extend so high that there aren’t even any branches on the tree for the first 100+ feet up the trunk.
By contrast, bushes have with multiple stems and branches that spread out from the base. And as a result, they tend not to be very tall, with most bushes no more than a few feet high, and even “tall” bushes typically don’t grow more than 10-20 feet high. Though they usually don’t need to be very tall, either, as the breadth of leaves at the base of a bush is more than enough to gather the necessary sunlight for photosynthesis.
In point of fact, recent research suggests that bushes tend not to grow as tall precisely because they don’t have to. They engage in a satisficing strategy of being just tall enough and broad enough to get the sunlight they need. It’s only the trees that grow tall, in part because once the tree grows narrow and high, it can only succeed and gain the sunlight it needs by outgrowing the other trees around it. Yet doing so means it’s absolutely essential that the tree establishes strong roots and a solid trunk, or it can’t grow tall enough to survive and thrive for long.
Accordingly, the oldest and tallest trees are generally the ones that wait the longest and grow the tallest before branching out, while those that branch out early are much shorter. Fruit trees, which tend to have a wide span of branches just 10-20 feet off the ground, typically only live for 35-45 years, and the Bradford Pear tree is well known to be one of the shortest-lived trees (at 15-25 years) because of its tendency to have a V-shaped trunk from its base – which means it’s only a matter of time before it grows to the point that it splits under its own weight, or alternatively is destroyed when a major storm comes through that its fragile branch split cannot withstand.
Of course, ultimately branching out, so a tree can grow the breadth of leaves necessary to gather sunlight, is crucial. Even the giant redwood eventually branches out. Although the most mature redwoods have no branches for the first 100+ feet of the tree trunk! Nonetheless, the point remains that the tallest trees are the ones that tend to wait the longest to branch out, and the earlier and broader a tree (or bush) branches, the less likely it is to grow as high or survive as long.
The Bush Strategy To Saving For Retirement
In the world of investing, most people save and accumulate for retirement like a bush (or at least, that’s what we advise them as financial advisors). Each bit of savings is allocated into a diversified portfolio, which like a bush with a lot of stems and branches, allows us to grow and bulk up over time.
After all, diligently saving “just” about $300/month in a diversified portfolio growing at 8% for 40 years is sufficient to grow a $1,000,000 portfolio (at least before taxes). Someone who is able to max out their entre $18,000/year 401(k) contribution for 40 years can accumulate a whopping $4.6 million in retirement savings.
However, as with the limitations of the bush itself, that’s about “as good as it gets” when saving for retirement like a bush. And most people won’t even be this successful, as the average American doesn’t have enough “excess” income to max out 401(k) contributions, at least not every year for 40 years, when you also have to navigate getting married, buying a house, starting a family, child care, college funding, etc. Not to mention that very few are able to earn enough to maximize their 401(k) contribution limit on top of even basic living expenses in the early career years.
Fortunately, having a $1M+ portfolio is still more than enough for most people to retire and live a comfortable live, and most retirees make due with even less (especially when supplemented by Social Security benefits).
Still, it’s important to recognize the limits of the bush strategy. You’ll likely never meet a Bush saver with more than $5M of net worth, unless he/she had an extraordinarily high income to save in the first place. And you’ll certainly never find someone with $10M who achieved it as a Bush. To do that, you have to be a redwood.
The Redwood Strategy To Building Substantial Wealth
One of the most interesting commonalities of the world’s richest people is that virtually all of them achieved their wealth by not diversifying for most of their lives. From Bill Gates’ shares in Microsoft to Jeff Bezos’ Amazon stock, Mark Zuckerberg’s Facebook shares, Larry Page and Sergey Brin’s Google, and the Wal-Mart shares of the Walton family… no one on the Forbes list of billionaires got there by diligently saving into a diversified portfolio. Instead, like the redwood, they stayed concentrated and focused in a single direction for a very long time. And in point of fact, for most of them, their primary wealth asset is still their company stock.
Nor is this phenomenon new. The first person to ever reach a nominal net worth of $1 billion was John D. Rockefeller, which at the time was a mind-number 2% of national GDP… and came almost entirely from the wealth of his company, Standard Oil! Similarly, Andrew Carnegie made his money from the Carnegie Steel Company, Henry Ford from Ford Motor, the Vanderbilt’s family wealth came from the family railroad and shipping business, and the bank that created J.P. Morgan’s wealth still bears his name.
Of course, as noted earlier, most people can accumulate more than enough wealth to satisfy their basic personal needs and retirement goals by simply saving and investing in a diversified manner like a bush, and not pursuing the redwood strategy of holding and compounding the growth of concentrated wealth. Nonetheless, the fact remains that entire orders of wealth magnitude are only effectively available to those who don’t diversify like the bush, and instead stay focused (and concentrated) like the redwood that reaches for the sky.
Plant Lots Of Seeds But Don’t Split Your Trunk By Diversifying Too Early
A crucial caveat of the redwood strategy is recognizing that most redwoods don’t actually make it. Researchers have estimated that seed viability of redwoods may be as low as 3%, and similarly there are estimates that as many as 90% of entrepreneurial startups end out failing. It is perhaps no great surprise – if the redwood strategy were easy, everyone would do it, and then no redwoods would stand out because all the trees would be that tall! But still, that means it’s risky to try to be a redwood. There’s a reason why bushes and shrubs are more viable in so many parts of the world.
Still, as noted earlier, the weakest tree is not the bush or the redwood, but the Bradford Pear – a tree that tries to grow tall like a tree, but branches out too early, inevitably collapsing under its own over-diversified weight. In other words, if you’re going to be a bush, be a bush, and if you’re going to be a redwood, be a redwood. The worst strategy is to try to grow like a redwood, but diversify like a bush… because you end up like a pear tree.
After all, imagine the wealth of Bill Gates if, after successfully growing and IPO’ing Microsoft, he had sold it all and diversified. It’s true that the S&P 500 is up almost 20X since 1986 when Microsoft went public. On the other hand, Microsoft is up 791X. In the past 20 years Amazon is up almost 640X. And the best performing stock, in terms of the cumulative performance of any company since 1926? Apple. Any diversification away from these companies, even after reaching “comfortable” wealth, would have ultimately resulted in substantially less wealth in the long run.
And arguably, a similar effect occurs in the growth of one’s personal career. The point, as made by Greg McKeown in Essentialism, is that focusing your energy in a limited number of directions can compound far greater results than spreading our energies in lots of directions at once. While it may feel “safer” to not put all of one’s eggs in a single basket, the challenge remains spreading one’s resources too thin too early just limits personal success.
Again, the tallest trees are the ones that wait the longest to branch out, as the Bradford Pear that splits its trunk early to “diversify” its opportunities just ends out splitting apart later, or quickly succumbing to external pressures because it lacks the solid core necessary to withstand natural forces.
Plant Redwoods When You’re Young, Grow Bushes When You’re Older
The fundamental point is that, while diversification is commonly lauded – for many good reasons – it has trade-offs worth considering. While having “too much” concentration of wealth can leave one exposed to greater risks, it’s also the path to greatest rewards. Diversification may preserve great wealth or impact, but seldom creates it.
Of course, growing the tallest trees also just takes time. It’s no coincidence that most of the world’s wealthiest billionaires are in their 60s, 70s, and 80s. Compounding takes a while.
Accordingly, it is arguably best to pursue Redwood strategies when you’re young. Not only because it allows for the longest time to grow and compound – if it works out well – but also because it allows time for alternatives if the concentrated redwood strategy doesn’t work out. In other words, if you plant a bunch of redwood seeds in your 20s and 30s, and none of them sprout, you still have time to plant some (diversified) bushes during the empty-nest phase in your 40s and 50s.
At the same time, though, what this analogy suggests is that there is such thing as diversifying too soon and too quickly. Whether it’s trying to build multiple income streams instead of focusing on one business, or trying to diversify wealth instead of allowing a closely held business to compound, the risk-minimizing nature of diversification is also a limiter of success, too. For many, that may be an acceptable trade-off – particularly if some level of success or affluence has already been achieved. But maybe it’s not such a bad idea for 20-somethings with a lot of wealth concentrated in company stock and options to just keep holding onto them and hoping it grows much, much bigger. The fact remains that the tallest trees are the ones that grow the highest before they branch out!
Or stated more simply, you can have a good life as a bush, but true wealth comes from being a redwood. Yet trying to split the difference and diversifying too early – acting like a pear tree – may be the strategy most likely to catastrophically fail!
So what do you think? Is the analogy of redwoods, bushes, and pear trees reasonable? Should investors be cautious about not diversifying too early? As advisors do we have a bias towards diversifying towards bushes and discouraging redwood entrepreneurialism? Please share your thoughts in the comments below!