We are all familiar with the idea of “the wisdom of Solomon” because he figured out how to discern the real mother of an infant by threatening to cut the infant in half and each woman could have half an infant. Of course the real mother said, “No, give it to the other woman” and their true identity was revealed.

Is there such a thing as the “wisdom of Solomon” when it comes to investing? Well, you betcha! And, it has powerful contemporary application. Here it is, Ecclesiastes 11:1-6 (ESV).

1 “Cast your bread upon the waters,
for you will find it after many days.
2 “Give a portion to seven, or even to eight,
for you know not what disaster may happen on earth.
3 “If the clouds are full of rain,
they empty themselves on the earth,
and if a tree falls to the south or to the north,
in the place where the tree falls, there it will lie.
4 “He who observes the wind will not sow,
and he who regards the clouds will not reap.
5 “As you do not know the way the spirit comes to the bones in the womb of a woman with child, so you do not know the work of God who makes everything.
6 “In the morning sow your seed, and at evening withhold not your hand, for you do not know which will prosper, this or that, or whether both alike will be good.”

The first principle in verses one and two is diversification to reduce risk. In Solomon’s case, he was referring to sending “bread”, the wheat and other grains harvested in Israel, on ships to other ports as trade. Sending your grain on a ship was risky but was the most efficient way to participate in trade. Take risk and after many days your profits will come back after the grain is sold.

Now to the diversification part, “Give a portion to seven, or even eight, for you know not what disaster may happen on earth.” Interpretation: Do your shipping on several ships, not just one. If a bad storm comes up on the sea your one ship may go down and you will have lost all (Can anyone spell Enron, Bear-Stearns or Lehman Brothers?). So, spread your shipping across multiple ships and multiple routes and reduce your risk of loss.

Diversification is primarily a way to reduce your risk of loss, not a way to make more profits. However, if you compare the results of a shipper who always spread his risk across several ships versus the merchant who always used only one ship, eventually the diversifier would make more profit. That is because statistically, both will lose a shipment occasionally and the diversifier will only lose part of his crop whereas the non-diversifier will loose 100% of that year’s crops (like Enron, etc.).

Carry this forward to contemporary equity or stock investing and the same principles apply. Diversify broadly and you will reduce the risk of loss and the risk of volatility of returns.

If I construct an equity portfolio of three funds, one with US stocks, one with non-US stocks of companies in mature markets and one with stocks from Emerging Markets and each of these own virtually every publicly traded stock in their respective markets, then I have diversified away every conceivable risk except one; market risk. And, I would own virtually the entire world stock market. Every time someone buys or sells and makes profit, I own a little (very little) piece of that deal.

Principle number two: Risk is everywhere, you can’t escape it.

3 “If the clouds are full of rain,
they empty themselves on the earth,
and if a tree falls to the south or to the north,
in the place where the tree falls, there it will lie.”

When rain comes it may be a nice rain to increase crops or it may be an old fashioned “gully-washer” and wipe out everything in sight. We have no control over this. We can do our best to apply good agricultural principles in how we plant and how we plow but some things are just overcome by the rains.

None of life is free of risk. Regarding investments there is inflation risk, interest-rate risk, company risk, industry risk, country risk, money-manager risk, currency risk, etc. Here a risk, there a risk, everywhere a risk – risk. Old MacDonald had a risk. Sorry… got carried away there.

Proper diversification can eliminate all of these risks except market risk; that is one risk an investor just can’t eliminate.

Principle three: Don’t procrastinate because of risk.

4 “He who observes the wind will not sow,
and he who regards the clouds will not reap.”

The farmer who is always waiting for calm winds before planning seed so it won’t get blown away will never get around to planting his seed and the farmer who is afraid to begin harvesting for fear the clouds will bring rain and cause his crops to rot in the field will never get around to harvesting his crops – no profit.

Does it sound familiar? I can’t invest because:

• Of the war in Iraq/Afghanistan

• Of the credit crisis

• Of the real estate/mortgage crisis

• Of the failure of Lehman Brothers

• Of the failure of Enron, WorldCom and Tyco

• Of the bursting of the tech bubble

• Of the recession

• Of the George W. Bush administration

• Of the Barak Obama administration

• Of the Republicans being in charge

• Of the Democrats being in charge

History is filled with excuses for not investing and accepting the risk of the equity markets and yet, since 1926 the large cap stock market has averaged approximately 10.5% per year. If one was willing to accept more volatility risk and invested in small cap stocks instead, the average return was much greater than 10.5%.

5 “As you do not know the way the spirit comes to the bones in the womb of a woman with child, so you do not know the work of God who makes everything.”

The world is complex and just as we don’t understand everything about the development of a child in the womb, we don’t understand everything about how God oversees the economies of the world and allows for profits to be made fairly consistently over time. If I diversify broadly enough, I don’t have to understand the minutiae of the markets to profit from investing in them. I know God has placed in man the desire to produce, to make profit, the desire to do better for himself and for his family and as long as man has sufficient freedom to pursue those interests, there will be profit, and profit is a good thing (this will be the subject of another article later). Go capitalism!

Principle four: Keep on investing

6 “In the morning sow your seed, and at evening withhold not your hand, for you do not know which will prosper, this or that, or whether both alike will be good.”

The picture here, again, is a farmer in the ancient near east. He is encouraged to sow seed all day long, from morning to night, because he doesn’t know which seed and which part of his fields will have all the right conditions to produce an excellent crop – or if none of it will. This is another way to approach diversification.

Regardless of the great efforts of our finest young MBAs to research the markets and make the best most informed decisions possible, the track record shows that we don’t really know which stocks will perform best or if, as over the past couple of years, none of the seed will do well. This past market decline was characterized by stock market losses in all markets, domestic, international and emerging markets. That was not anticipated and it is unusual. Some have referred to this as a “Black Swan” event. When looking at a flock of swans, you don’t expect to see a black one, but occasionally you will. We did!

So, lets review quickly the Wisdom of Solomon regarding investing.

1. Diversify broadly to reduce risk.
2. Risk is unavoidable. There is no such thing as a risk-free investment.
3. Don’t procrastinate because of risk.
4. Keep on investing.

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"Investor Education for Main Street America"