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diversification that can be readily obtained by purchasing mutual fund
shares.
Shane totally disagreed. He said, “Diversification! Who needs it?” He
thought that what one must do is look carefully at stocks possessing
desired risk-return characteristics and then invest all one’s money in the
single best stock. Walt told him he was crazy. He said, “There is no way
to measure risk conveniently—you’re just gambling.” Shane disagreed.
He explained how his stockbroker had acquainted him with beta, which
is a measure of risk. Shane said that the higher the beta, the more risky
the stock, and therefore the higher its return. By looking up the betas for
potential stock investments on the Internet, he can pick stocks that have
an acceptable risk level for him. Shane explained that with beta, one
does not need to diversify; one merely needs to be willing to accept the
risk reflected by beta and then hope for the best.
The conversation continued, with Walt indicating that although he knew
nothing about beta, he didn’t believe one could safely invest in a single
stock. Shane continued to argue that his broker had explained to him that
betas can be calculated not just for a single stock but also for a portfolio
of stocks, such as a mutual fund. He said, “What’s the difference
between a stock with a beta of, say, 1.2 and a mutual fund with a beta of
1.2? They have the same risk and should therefore provide similar
returns.”
As Walt and Shane continued to discuss their differing opinions relative
to investment strategy, they began to get angry with each other. Neither
was able to convince the other that he was right. The level of their voices
now raised, they attracted the attention of the company’s vice president
of finance, Elinor Green, who was standing nearby. She came over and
indicated she had overheard their argument about investments and
thought that, given her expertise on financial matters, she might be able
to resolve their disagreement. She asked them to explain the crux of their
disagreement, and each reviewed his own viewpoint. After hearing their
views, Elinor responded, “I have some good news and some bad news
for each of you. There is some validity to what each of you says, but
there also are some errors in each of your explanations. Walt tends to
support the traditional approach to portfolio management. Shane’s views