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moneysense.ca, 30/11/05
To Not Diversify is Just Stupid
Robert Kiyosaki claims in his column on Yahoo! Finance that only amateurs diversify and professional investors should instead focus their investments. He even quotes Warren Buffett on the subject. Fair enough. But, the last time I checked there are just a handful of investors who are as successful as Mr. Buffett and there are probably millions of extremely smart professional investors. So, the odds are stacked against an investor who wants to focus.
Mr. Kiyosaki’s specious argument goes something like this: Mr. Buffett focuses his investments and is successful. Many rookie financial planners suggest diversification and their clients are not wealthy. Therefore, if you want to be wealthy don’t diversify!
Many very smart investors preach the virtues of diversification: Burton Malkiel, Ted Aronson, David Swenson to name just a few. And from my personal experience, beating a low-cost diversified portfolio of index mutual funds or ETFs is extremely difficult. Also, the vast majority of mutual funds, all of them run by professional investors, fail to beat their benchmark indices even before taking taxes into account. Not to mention, the sorry record of individual investors who focused their portfolios on technology and got killed in the bear market. Just don’t forget Mr. Buffett’s advice: “Rule # 1: Don’t lose money. Rule # 2: Don’t forget Rule # 1″.
Also, check out posts on this subject on Investing Intelligently and Consumerism Commentary.
Note: Just one day left to enter the One Year Anniversary Giveaway.
moneysense.ca, 30/11/05
If, like Mr. Buffett, you develop a successful criteria for finding companies to invest in, the lower risk in your investments allows a lesser need to diversify.
However, Mr. Kiyosaki is no Warren Buffett, he’s a motivational speaker. Many of the people who (unfortunately) listen to him are not Warren Buffett either… they’re teachers, pilots, etc.
The diversification should reflect the risk in your portfolio. If you know the companies have long-term value (ie – Warren Buffett) and are not afraid of short-term fluctuations in value, then you afford less diversification.
you mention the sorry individual investors who got killed by the tech bear, as an example to confirm your theory that diversification is better than focused investing……the works of many individuals such as Tharp would suggest that position sizing and stop losses are have a much greater impact on returns than even stock picking. You can’t compare mutual funds and their performance to an individual’s performance without examining the cost structures associated with each.
MER’s, trading fees . etc eat up alot of return not to mention mutual funds are run under very strict business models that require their participation in the market even when perhaps the fund managers would personally NOT want to commit capital. Well run hedge funds on the other hand have historically shown that they can and do , by way of leverage and flexibilty, out perform the market…. HOWEVER, poorly run hedge funds have shown that they can drastically underperform as well……
What I am trying to say is that individuals , who are knowledgeable , have several distinct advantages over mutual funds,….flexibilty and costs and this would allow them to use focused invested to their advantage…….Diversification by it’s very nature reduces potential return, the theory being you also reduce risk…My thoughts are that you can reduce risk through position sizing and stop losses without impacting potential return to the same extent
I’m rambling because I just had coffee and am trying to burn off some energy I hope this makes sense.
doctoth: my argument is not that focussed investing is not superior. You bet it is. I wish I had loaded up on Energy two years ago. I’d be laughing now. My point is only that it is extremely hard to beat the markets. BTW, I am not a fan of mutual funds (as you might have noticed
). Investors can build a diversified portfolio very cheaply using index funds.
personally I like using the i-units, or etf’s as a trading/ investing medium. xeg-t and xgd-t and xsp-t are my current holdings and I can trade around my core position,,,my thoughts are that energy and gold are in secular bull markets……
you have a great little site by the way
I still think you should look into position sizing…..you’d be quite surprised at how much you buy and how much you risk has more to do with your profits and losses in both investing and trading
[...]To Not Diversify is Just Stupid“: “In a recent article, Robert Kiyosaki (of Rich Dad fame) suggests that investors looking to succeed should focus their investments and not diversify. While it is true that some very successful investors concentrate their portfolio, not diversifying is a terrible idea for the vast majority of investors.” [...]
I normally don’t do this, but I completely disagree with you. No offense, as I like your blog.
http://www.wealthjunkie.com/2005/10/03/diversifying-is-for-losers/
Rich Dad give some extreme advice. I don’t take anything he says seriously. But often there is a tiny grain of sense in what he says if you think about it long enough to remove a lot of the nonsense from it.
Here’s what I got from the article: I’m not Warren Buffet. I have no system. I don’t have enough capital to test a system, if I had one. I will diversify, but that doesn’t mean I will do it passively by letting a financial/mutual fund advisor do it for me. I’m a big girl and can invest in etfs on my own. If I want to play the focus game, I do it like a scientist. I use stock simulators to test theories and statistical programs to refine theories.
First of all let me start of by saying this Kiyosaki is a scammer. He made his fortune by showing people how to get rich, he never did it himself. And for this reason alone, I don’t think anything he says has any validility.
But, you look at some very successful investors over the course of the last century, and you will find, that yes they are less diversified in the companies they invest in. But what makes them the most successful, even if they are diversified, is they made the big investments in the companies that went up the most. In other words, they knew where to put the money, and put the most money in the greatest reward.
Receiving a degree in finance, I was schooled in diversification and shown all these formulas and correlations and what not, but what always puzzled me, was how are you supposed to make money if when x is down, y is up. you’re hoping that x and y are up together at some point so that you can record a profit.
I personally feel that if you do your due diligence, ask the right questions, and more importantly, can hold during a downturn if the fundamentals remain, you will be successful. What happens is usually when a stock price goes down, people will doubt their ability to analyze a company and sell, instead of buying at a better price.
I like your blog, I’m going to post a link to you from my site.
Gualberto Diaz
gualberto.diaz@gmail.com
http://money.gmoneynyc.com
Warren Buffett had it right on diversificatiion when he said that “once dumb money realizes its limitations it then ceases to be dumb.” That is, once “dumb money” recognizes its lack of interest in macroeconomics & business analysis and subscribes to passive-indexing, it becomes “smart money.”
I happen to like learning about macroeconomics and business analysis. So, not surprisingly, I have a different perspective than passive indexers on asset allocation. Conventionally, holding different asset classes is advised because it may do one of two things. It may reduce the overall volatility of your asset portfolio. Or, it may spread the risk profile of your total asset holdings, if each asset class performs well in a different environment relative to the others. At best, that provides mediocre returns over the long term; at worst, that ensures exposure to bearish market trends over the near term. In contrast, I suggest holding assets that minimize household operating expenses and/or that are participating in bullish primary trends.
By way of example, owning your house insulates you from the rental increases in an inflationary environment; also, whether the price of the house increases or decreases, what do you care? Participating in commodity-related equities ensures exposure to a segment of the equity market that is experiencing a bullish primary trend. Avoiding general equity market plays and bond plays when both are over-valued ensures little or no exposure to the bearish primary trends in the general equity market and the bond market.
As to Mr. Kiyosaki, he has ably leveraged the intellectual property rights in his books after their adoption by Amway. Nothing more, nothing less. To my mind, he is not a subject matter expert in finance. If retail investors like ourselves want to learn about finance, we need only turn to true subject matter experts like Mr. Buffett and John Bogle of Vanguard.
Suresh
http://www.incometrap.com