Why Diversification is Bad Investment Advice
This is an update to an Article I wrote back in 2005, reference that here.
If you want to be rich, you must learn to focus
Have you ever heard this advice: "Invest in a diverse portfolio of stocks, bonds, and mutual funds"?
Seems like good advice, doesn't it? What could possibly be wrong with spreading your risk among a number of different investment vehicles?
Why diversification is bad advice
For one thing, what most people consider as diversification isn't really diversification. Rather it is spreading your money across one asset class. Stocks, bonds, and mutual funds are all part of the same asset class-paper assets. That is not true diversification.
There are actually four asset classes: paper, real estate, commodities, and business. A truly diverse portfolio would have stakes in all or most of these.
Beyond that, diversification is a zero sum game. Gains in one class offset loses in another. Sure, it can be safe, but rarely does someone become wealthy by diversifying. As Warren Buffet says, "Wide diversification is only required when investors do not understand what they are doing."
The most successful investors don't diversify. Rather, they focus and specialize. They get to know the investment category they invest in and how the business works better than anyone else. For example, when investing in real estate, some investors focus on raw land while others focus on apartment buildings. While both are investing in real estate, they are doing so in different ways.
When diversification makes sense
So why do financial advisors recommend diversification when the world's greatest investors choose 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; therefore, 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, they have all focused intensely in order to win.
Rather than practice diversification, I encourage you to practice focus. In the process you will take control of your financial future in ways that amateurs simply cannot.