Warren Buffett, one of the world's greatest investors, said, "Diversification is a protection against ignorance. It makes very little sense for those who know what they are doing."
Many financial advisors recommend that you diversify for your own protection. What they fail to tell you is that it is also for their protection. Since most financial advisors cannot tell you exactly which stock or mutual fund is a great investment, they tell you to buy a bunch of them.
Instead of diversifying, my rich dad taught me to focus on finding the best investments. That meant sifting through hundreds of offers, studying, analyzing, and determining the pros and cons of each. Learning to focus was one of the best real-world business lessons I received from my rich dad. It helped me become a better entrepreneur and investor. Focusing on investments also allows me to make more money with less risk, because I'm not buying a bunch of sub-par assets and praying they will do something.
Meet Your Financial Advisor
In a previous column, I wrote about the Employee Retirement Income Security Act (ERISA), which eventually gave birth to programs such as the 401(k). One of the reasons ERISA is significant is because it forced millions of employees to become investors, investors without any financial training or education.
This was a big boost to the financial services industry, which set out to hire thousands of people to service this new group of employees who needed to become investors. Suddenly, people without much financial education became "professional financial advisors." School teachers, used car salesmen, housewives, and insurance agents found new careers as financial advisors selling investments to people just like themselves.
A recent article in a Denver newspaper featured the plight of United Airlines pilots who lost much of their pensions due to the company's bankruptcy. When one retired pilot was asked what he was going to do now that his pension had been cut from $11,000 a month to $2,300 a month, the 62-year-old pilot said, "I'm going to become a financial planner."
I'm pretty certain he, too, will recommend diversification.
Two Factors That Justify Diversification
So why do financial advisors recommend diversification when the world's greatest investor chooses not to diversify? I believe there are two answers to this question.
1. Active vs. passive investing. There are active and passive investors. Warren Buffett is an active investor. Most people are not. Active investors should focus. Passive investors should diversify.
2. Risk. Some investments are riskier than others. Stocks, bonds, mutual funds, and real estate investment trusts (REITs) are very risky investments, hence you should diversify if you invest in them. If you invest in businesses, as Warren Buffett does, or real estate, as I do, you should focus.
The real question is: Do you want to become a professional investor or remain an amateur? If you choose to remain an amateur -- a passive investor -- then, by all means, diversify. Diversification keeps you from "putting all your eggs into one basket," so if one industry collapses -- as tech did famously in 2000 -- only a portion of your portfolio will be affected.
If, however, you decide to become a professional investor, the price of entry is focused dedication, time, and study. Warren Buffett dedicated his life to becoming the best investor he could be. That is why he focuses and does not diversify. He does not need to protect himself from ignorance simply because he has invested time and money to understand what he is doing.
Intense Focus, Intense Rewards
In Hawaii, there is a great organization known as Winners Camp. It teaches teenagers the attitudes and skills required for success in life. Winners Camp uses the word "focus" as an acronym, standing for "Follow One Course Until Successful." I believe all children should be taught to focus, as should any investor who wants to be a rich investor.
If you look at anyone who has achieved great success and wealth, people like Warren Buffett, Oprah Winfrey, or Lance Armstrong, they have all focused intensely in order to win.
One of the reasons the rich get richer is because they are focusing, while the middle class is diversifying, and the poor are counting on Social Security.