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is 33 years old, currently lives in Princeton, New Jersey. Shane, who
is 35, lives in Houston, Texas. Recently, at the national sales meeting,
they were discussing various company matters, as well as bringing
each other up to date on their families, when the subject of
investments came up. Each had always been fascinated by the stock
market, and now that they had achieved some degree of financial
success, they had begun actively investing. As they discussed their
investments, Walt said he thought the only way an individual who
does not have hundreds of thousands of dollars can invest safely is to
buy mutual fund shares. He emphasized that to be safe, a person
needs to hold a broadly diversified portfolio and that only those with a
lot of money and time can achieve independently the 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