Excerpt from the Free Book: What Every Investor Needs to Know
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DEMYTHIFYING DIVERSIFICATION
A while back, Wall Street stumbled upon the greatest sales tool imaginable: the diversified portfolio. It goes with the “buy-and -hold” mantra the way chocolate syrup goes with vanilla ice cream. And although it sounds good, it is about as good for your financial health as a double sundae is for your waistline.
It all started when some intelligent academic types observed that an investor could reduce stock risk by holding a number of stocks that are not perfectly correlated. This means that some stocks zig while the others zag, and the zigs offset the zags. Theoretically, these academics reasoned, a diversified portfolio of stocks will reduce risk and yield the same return as a good single stock pick.
Wall Street took hold of the concept of diversification and went to town. Twisting the thesis to fit their own goals, they told their clients that it no longer made sense to own just one mutual fund. Despite the fact that the original fund was already diversified, they advised clients to own a number of mutual funds. Those new mutual funds they pitched were completely unknown to the client and some invested in risky undeveloped markets. Meanwhile, the brokers counseled those same clients to keep holding any losing stocks they purchased a few months back. Just because it’s down, the argument went, doesn’t mean it was a bad trade. The current losers, the brokers said, were sure ways to make big money in the future and would serve to diversify the client’s portfolio. The brokers used “diversification” as an opportunity to pitch any number of stocks to the client because it was a way to sell all kinds of new junk while distracting the client from the broker's poor prior pick.
DEBUNKING THE MYTHS
The Blue Chip Stock Trader team enjoys studying investment and portfolio theory. Our top picks in investment books are listed on this webpage. We won’t bog you down here with an explanation of the application of diversification to making money in the stock market except to say, don’t worry, diversification happens. As a real- world investor who is trying to make money in the stock market it is not worth your time to seek diversification at the expense of profitability. Steer clear of the manufactured myths, don’t eat the tripe that Wall Street feeds you, stick to the basics, stick to facts, and use common sense to win in the market. That’s what Blue Chip Stock Trader does.