The Man Behind George Soros Is Dead Wrong

Yet, I feel that I must, especially because doing so should help you make more money and lose a lot less. So listen up.

I can't believe he said this

Enter Jim
Rogers: George Soros' former partner, co-founder of the Quantum Fund,
and a truly legendary international investor. This is a guy who helped
generate a 4,200% total return over a 10-year period -- which
is amazing, to say the least. Now that kind of performance almost
guarantees you the right to say whatever you want about investing
without fearing criticism from us non-legendary folk.

But consider what Jim said in a recent interview with BusinessWeek:

Diversification is something that stock brokers came
up with to protect themselves, so they wouldn't get sued. Henry Ford
never diversified, Bill Gates didn't diversify. The way to get rich is
to put your eggs in one basket, but watch that basket very carefully.
And make sure you have the right basket.

You can go broke diversifying. Ask anyone who's diversified in the last three years. They've lost money.

That's just fraught with bad advice

First,
diversification is not some silly device that stock brokers created to
protect themselves. Diversification is a necessary process that has
emerged out of man's evolution on this planet. It explains why families
have more than one child. It explains why empires sent more than one
ship to explore new worlds.

Bad stuff happens completely unexpectedly on Planet Earth. And
because of this, human beings have developed ways and means to cope
with the inherent uncertainty of life.

So forget the broker talk. To diversify is to be human.

They call this next one "survivorship bias"

Next,
Mr. Rogers cites two of the 20th century's most recognized businessmen
as reasons not to spread your wealth: Henry Ford and Bill Gates. These
are two folks who supposedly never diversified and wow, look at them now.

Even assuming Jim is right -- that Ford and Microsoft (Nasdaq: MSFT)
didn't diversify (which I seriously doubt) -- he hasn't given you the
complete picture. What about all those glorious souls who didn't have
as much success as Mr. Ford and Mr. Gates and who didn't diversify at
all? They're broke, starving, or homeless -- and, as we all know, in
far greater numbers than the Fords and Gateses of the world. Putting
all your eggs in one basket might work. But, when it doesn't, you're screwed.

Diversifying can't make you rich?

My biggest beef with Mr. Rogers' statement is that he tries to convince you that diversifying can't make you rich.

That. Is. Simply. Not. True.

For one, legend Shelby Davis (of the Davis Funds) produced $800
million from a base of just $100,000, investing in more than a thousand
stocks -- and rarely selling them. Other diversified investors have had
tremendous success. Names like Peter Lynch, Sir John Templeton, and
Philip Fisher come to mind.

The straw that broke the camel's back 

Mr.
Rogers concludes, "Ask anyone who's diversified in the last three
years. They've lost money." Well there's an insightful statement for
you.

The market is down more than 20% in the past three years. Unless you were only holding Wal-Mart (NYSE: WMT) or McDonald's (NYSE: MCD) or you were sitting 100% in cash, it's overwhelmingly likely that you lost money in some way -- diversified or not.

And despite diversifying my own investments quite a bit, I still
found my 401(k) with losses north of 25% over the past year. But I'm
still here, I still have my shirt, and I'm still in the game. That's
what's important. Others who didn't diversify may not be in the same
position.

Don't just watch: "closely" watch

So how does Mr. Rogers suggest combating the most substantial stock market losses of nearly a century? He suggests closely watching your highly concentrated basket.

Ohhh, closely watching my basket ... now I get it ... wait, what?

Just how closely would I have to watch stocks that I
thought I knew pretty well in order to achieve the results that Jim is
talking about? Consider how well you thought you knew these stocks in
2006:

Even individuals who were about as "close" to these companies as one
can come (employees) have lost tremendous amounts of money. And these
are all strong names with relatively simple businesses -- they aren't
the AIGs, Bank of Americas, or General Electrics (NYSE: GE) of the world that we've all come to know and love.

Well-respected fund manager Chuck Akre, of Akre Capital Management,
had an astute observation on this subject. Sitting here in Fool HQ on
one lazy afternoon discussing the recent financial collapse, Mr. Akre
said, "The only thing that goes up in bear markets is correlation."
Amusing as it was, it's true. A severe market correction will affect
almost all investors, but being diversified will ensure that you're
still in the game when the market bounces back.

So what's the point?

My simple point is
this: Never risk more than you can afford to lose on any one, unknown
event -- never. And stocks, by golly, (no matter how "closely" you
watch them) are inherently unknown. If the prospect of losing 100% on
any one position terrifies you, you're probably overly concentrated.

Watching your stocks closely or not, you'll still find yourself
blindsided by unforeseen or unforeseeable events. Mr. Rogers, of all
people, should know that it is precisely the risks we cannot or do not anticipate that are the ones that lead to outright destruction.

The Foolish bottom line

If you can always
pick the winners and miraculously wind up never hitting a loser, then
go ahead and forget diversification. But don't forget, the absolute
best investors are still wrong about 40% of the time. In other words,
at some point, on some stock, there's a strong chance you'll face total
destruction if you don't diversify. It's almost mathematically
inevitable.

Instead, buy a basket of the greatest stocks. Some investments will
lose, some will win. But the winners are likely to far make up for the
shoddy performance of the losers -- so much so that you'll be that much
more grateful for all the extra sleep you will get because you're not
fretting about your overconcentrated portfolio.

Copyright © 2009 Universal Press Syndicate.