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Wall Street would have you believe that the most effective way to hedge against unknown market risk is to diversify your portfolio.
The theory is pretty elegant – or at least it's supposed to be.
Spread your money around, they say, and you'll reduce your risk because "everything can't possibly go down at once."
Problem is, that's a load of self-serving hooey.
Today's markets are more correlated than they've ever been, thanks to a witches' brew of computerized trading, exchange-traded funds (ETFs), and leverage.
You've got to do something different if you want to get ahead.
Many folks find that hard to believe.
The correlation part, I mean.
Wall Street spends billions on advertising to highlight the virtues of diversification. There are countless books on the subject. Academia considers it a cornerstone of investing education. So, alas, it must be true.
Legions of investors want to believe that, but…
Here's a shot of the Dow, the S&P 500, the Nasdaq, and the Russell 2000, all plotted together since late 1998. Even the most hardened critic can see that the major indices are moving in near lockstep.
Especially on big down days.
Source: Yahoo! Finance
What's more, you can see that – aside from one big bump ahead of the Internet Bubble in 2000 – all of the indices get even more "alike" after 2003 and 2009, as correlations are generally increasing over time.
Still, Wall Street peddles its wares to the unassuming.
"Buy the indices," they say.
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"You can't beat the markets," they charge – with the implication of "So why even try?"
Yeah, and I've got a bridge to sell you.
Warren Buffett – yes, THAT Warren Buffett, who's worth an estimated $86 billion – says diversification "is protection against ignorance." Moreover, he observes that [diversification] "makes very little sense for those who know what they're doing."
Spread yourself and your money too thin, and you will never, ever beat the markets. Worse, you WILL compromise your results.
Buffett, incidentally, is not alone any more than we are.
Other great investors go to great lengths to concentrate their investments. Names like George Soros, Jim Rogers, and Doug Kass all come to mind.
William O'Neil even went so far as to say that the winning investor's "objective should be to have one or two big winners rather than dozens of very small profits."
My favorite take, though, comes from money manager James Oelschlager, founder of $1.1+ billion investment management firm Oak Associates. He wryly observed that "no hospital wings or college dormitories have ever been named by an indexer."
Critics, of course, will scream bloody murder when they read this. "International markets are different," they'll challenge. "Diversify by sector," they'll counter.
Good luck with that.
Recent changes in the fiduciary laws make it all but impossible for financial advisors or money managers to set up a concentrated portfolio because they're legally obligated to spread your money around by "acting in your best interest."
And – you guessed it – that's officially a diversified portfolio because a concentrated portfolio runs contrary to commonly accepted wisdom.
Which brings me back to where we started.
About the Author
Keith Fitz-Gerald has been the Chief Investment Strategist for the Money Morning team since 2007. He's a seasoned market analyst with decades of experience, and a highly accurate track record. Keith regularly travels the world in search of investment opportunities others don't yet see or understand. In addition to heading The Money Map Report, Keith runs High Velocity Profits, which aims to get in, target gains, and get out clean. In his weekly Total Wealth, Keith has broken down his 30-plus years of success into three parts: Trends, Risk Assessment, and Tactics – meaning the exact techniques for making money. Sign up is free at totalwealthresearch.com.