On Diversification Get your helmets, because I'm about to rock your face off. Unless you believe in the efficient market hypothesis, in which case you should quit reading and try to find a high paying job, because you won't make it in the market. (For the record, anything quoted will be from Warren Buffett or Benjamin Graham, I see no need for diversification of sources.)
It is next to impossible to watch or read any investment advice aimed at the mass market that doesn't include meaningless buzzwords, specifically, the word diversification. Diversification is meant to be the logical extension of the old adage, "Don't put all your eggs in one basket." This makes sense, provided you know nothing about the market and are trying to do nothing other than match the averages of the major indices over the years.
Most people rely on diversification because it seems safe, or less risky. However, I say that risk is relative, and is directly related to skill, knowledge, and experience. Since I love market/poker parallels (read this for an explanation the zero-sum nature of both), I'll draw on that. In the movie Rounders, Mike McDermott (Matt Damon) narrates the comment, "there is no risk in this room" while walking into a game. This doesn't mean that the game isn't inherently risky, it means that he is so much better than the other players that his chances of losing over the long run is negated. This is the same in the market, the market is incredibly risky for Johnny Speculator coming off his efficient market hypothesis education at Podunk community college, a bit less so for me, and much, MUCH less for Warren Buffett. So logically, if beating the market averages consistently is your goal, less and less diversification is needed to maintain a margin of safety as your ability (the sum of skill, knowledge, and experience) increases.
Future posts will include an explanation of why the stocks I own are less risky than average, and an adequate definition of value investing (as opposed to price speculating, which is what a majority of "investors" do). Questions?
It is next to impossible to watch or read any investment advice aimed at the mass market that doesn't include meaningless buzzwords, specifically, the word diversification. Diversification is meant to be the logical extension of the old adage, "Don't put all your eggs in one basket." This makes sense, provided you know nothing about the market and are trying to do nothing other than match the averages of the major indices over the years.
"A situation requiring wide diversification occurs when an investor who does not understand the economics of specific businesses nevertheless believes it in his interest to be a long-term owner of American industry. That investor should own a large number of equities and space out his purchases. By periodically investing in an index fund, for example, the know-nothing investor can actually outperform most investment professionals. Paradoxically, when 'dumb' money acknowledges its limitations, it ceases to be dumb."However, if you were trying to pick an investment firm (for the reason that you think they should be able to beat the market consistently, because any idiot can buy an ETF or mutual fund of the market on his own) the more diversification they push, the harder it will be for them to provide a rate of return that differs significantly from the market averages. If you are perfectly diversified (owning everything) then your return will match the market exactly- I do not want this.
Most people rely on diversification because it seems safe, or less risky. However, I say that risk is relative, and is directly related to skill, knowledge, and experience. Since I love market/poker parallels (read this for an explanation the zero-sum nature of both), I'll draw on that. In the movie Rounders, Mike McDermott (Matt Damon) narrates the comment, "there is no risk in this room" while walking into a game. This doesn't mean that the game isn't inherently risky, it means that he is so much better than the other players that his chances of losing over the long run is negated. This is the same in the market, the market is incredibly risky for Johnny Speculator coming off his efficient market hypothesis education at Podunk community college, a bit less so for me, and much, MUCH less for Warren Buffett. So logically, if beating the market averages consistently is your goal, less and less diversification is needed to maintain a margin of safety as your ability (the sum of skill, knowledge, and experience) increases.
"If you are a know-something investor, able to understand business economics and to find five to ten sensibly-priced companies that possess important long-term competitive advantages, conventional diversification makes no sense to you. It is apt simply to hurt your results and increase your risk. I cannot understand why an investor of that sort elects to put money into a business that is his 20th favorite rather than simply adding the money to his top choices- the business he understands best and that present the least risk, along with the greatest profit potential. In the words of Mae West: "Too much of a good thing can be wonderful."Now for some real life application- over the past six weeks, all the major indices have suffered significant erosion of value until recently, when they have rallied back to near previous levels. A perfectly diversified investor would have experienced significant unrealized losses while eventually breaking close to even , while a non-diversified, "intelligent investor" has the possibility to beat the market averages. Fortunately, I am one of the latter. My limited portfolio (containing two stocks) returned around $600 on a $7200 investment, or roughly 8.3%- I rock.
Future posts will include an explanation of why the stocks I own are less risky than average, and an adequate definition of value investing (as opposed to price speculating, which is what a majority of "investors" do). Questions?
posted by Justin at 12:56 PM 
9 Comments:
Where did you get $7200 to invest in the first place?
My confirmation word is "skdidyi" which I believe is a genetic mixture between an insect and a feared Skarrj warrior from Unreal.
It's my college tuition money plus some money from one of my friends. Why I invested it all is part of a later financial post...
since i havent commented on a post lately and you have been bitchy like a little....bitch, i guess i will but it will have nothing to do with your post so.....i just wanted to say if brock was a real person i would give him a hand job, using both hands cause im assuming he is huge and i would love every second of it!
My helmet won't even fit because my head is so swollen from having its face rocked clean off.
I just googled, unruly pubic hair and for some reason it directed me here. Anyways, good post.
I think we are all wondering, "Who is that guy?"
You shouldn't put all your eggs in one basketball. Just because you should be able to count on something doesn't mean you can. For example, I should be able to count on my paycheck being directly deposited every other week, however today the payroll company screwed causing problems for some. Diversification is good because stuff that shouldn't happen does happen.
I'll give you all of my college tuition. You're a genius. Remember the little people. And the big people who don't make as much money as you, and the stupid people who can't understand a word of what you're saying. I'm not one of the latter, but then again I didn't google for pubic hair - I've got my own, thanks.
basket not basketball
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