The Man Behind George Soros Is Dead Wrong

Calling out a master investor is analogous to standing in the middle of an open field and calling down the very thunder of Zeus. You're really asking for it.

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:

Company

3-Year Return

FedEx (NYSE: FDX  )

(52%)

Starbucks (Nasdaq: SBUX  )

(61%)

Harley-Davidson (NYSE: HOG  )

(66%)

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.

You can achieve this by investing with the Motley Fool Stock Advisor service -- a diversified basket of stocks that's beating the market by an average of 40 percentage points since the service's inception. Click here to read the write-ups on all our recommendations, free for the next 30 days.

Above all else, please don't risk the wrath of the gods by letting it all ride on a tiny number of positions. Blowing up doesn't feel good.

Fool writer Nick Kapur owns shares of Microsoft. He enjoys thunderstorms, but doesn't really like to call down the thunder. Starbucks and FedEx are Stock Advisor recommendations. Wal-Mart, Microsoft, and Starbucks are Inside Value recommendations. The Fool owns shares of Starbucks and has a disclosure policy.


Read/Post Comments (21) | Recommend This Article (40)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 20, 2009, at 8:46 AM, whereaminow wrote:

    Jim painted with too broad of a brush in the diversification statement.

    Diversification has led many people to completely ignore the actual viability of their investments. "I'm diversified, therefore I don't have to think." I doubt Jim would consider Peter Lynch to be among those who fall into that category.

    But many hard working people have been told that diversification will protect them. That is also a load of baloney. The only thing that will protect you is you. If you put all your eggs into the diversification basket, and then fail to watch that basket, you will find yourself ripped off (at worst) or with terrible returns (on average) or a nice retirement (if you were lucky enough to pick a good fund with a good manager - something most people rarely research.)

    Diversification has been sold to young people as the answer to all their fears about retirement. That's nonsense. When I was in the service, they used to bring in fund managers to get young servicemen and women to sign up. They knew nothing about the market or the risks, but were promised 11% returns annually thanks to the magic of diversification. Those fund managers were charlatans.

    Let's put it another way. What qualifies a fund manager to manage billions of dollars of capital? They passed some exams? What businesses have they grown? What experience do they have managing their own money? Very few (there are exceptions) meet my expectations of qualification.

    Bonus trivia: What type of economic system rests on the belief that passing examinations qualifies you to manage large amounts of capital? (Hint: It's not Capitalism)

    David in Qatar

  • Report this Comment On June 20, 2009, at 6:10 PM, Buckaneer wrote:

    GE has far from a "simple business," last time I checked they are in - to name a few:

    lightbulbs, jet turbines, media ownership, loans (which hurt them), etc.

    All this from General "Electric"

  • Report this Comment On June 20, 2009, at 8:40 PM, slowtrain79 wrote:

    I agree with Rogers. I think he what he really was talking about is over-diversification. Even if you have a large account (over 1 million) you shouldn't own more than 5-6 stocks. It is impossible to "watch the basket closely" as he says if you own more than that. How can anyone really expect to completely understand and follow 20-30 companies and their respective industries really well?

  • Report this Comment On June 20, 2009, at 10:18 PM, Mrakaronni wrote:

    Diversify into the business types you personally know best - this may only be 2 or 3. Wide diversification does not assure profit. What if I diversified into all failing industries or companies? A "same" bettor never makes money. Bet infrequently, but bet big.

    "whereaminow" had a wonderful observation: What qualifies a fund manager to manage billions of dollars of capital? They passed some exams? What businesses have they grown? What experience do they have managing their own money?

    I have stated for a long time that it is easy to lose someone else's money. I wonder how those funds (and fund managers) would perform if they were required to put 50% of their pay into their own funds?

    Passing an exam and getting a license does not automatically make someone a wise investor. The most financially successful people I know did it on their own. They won, they lost and they learned - with their own money.

  • Report this Comment On June 21, 2009, at 10:29 PM, TMFJoeInvestor wrote:

    Great piece, Nick.

  • Report this Comment On June 22, 2009, at 2:51 PM, JakilaTheHun wrote:

    Why does the anti-diversification crowd always try to shove their own views down everyone's throat? I don't get it. It's like they have an emotional attachment to non-diversification.

    The fact of the matter is that you can handily beat the market with heavy diversification. My portfolio at KaChing has beat the market by over 50%+ over the past six months despite having nearly 100 positions. Not only was I able to achieve those returns with heavy diversification, those returns may not have been possible without it.

  • Report this Comment On June 22, 2009, at 2:58 PM, dudemonkey wrote:

    Jakila, I guess Jim's next question would be "how would you have done only holding your best 5 stocks?" If your response to that is "how am I supposed to know which are going to be the best 5", diversification is definitely for you.

    Diversification is great if your system calls for it. No more, no less.

  • Report this Comment On June 22, 2009, at 4:09 PM, pberardi wrote:

    Jim Rogers is spot on. Read the Millionaire Next Door. Most affluent successful people own small businesses or companies or they work for people like that. Most of their wealth is tied up in one asset; their business.

    Most Americans don't become Bill Gates or Steve Jobs. These are America's great entrpreneur success stories. So Bill Gate's wealth is his Microsoft stock holdings just like my boss's wealth is tied up in his $40 million privately owned small company.

    The Wealth is the company's ability to generate cash and its' market value when he sells.

    My boss invests in GNMA's, T-bills and some real estate. He did not rely on the stock market to become wealthy. He like Bill Gates invested in himself. He invested in his ability to own and operate a successful business. That's the true intangible wealth that we ignore.

    Even Warren Buffett says that you must be diversified but also make big bets on some stocks.

    As for the typical worker who must save and sacrifice consumption to attain affluence, diversification is fine but I've come to the realization that putting 10% of your salary in S&p500 index funds and bond index funds won't make you rich.

    It will provide a better return than spending it all. That's a prescription for a life on social security.

    Also. Jim Rogers made money selling books and engagements. This generates cash for him to take positions.

    Had I had all my money in ABT and PG instead of 5% I would have lost 10% during this downturn. That's a far cry from 40%. However, I'm now in the process of reducing my holdings from 40 stocks and a "gazillion" mutual funds to 10-12 stocks and 4 index funds from the S&P to International.

    Let's not confuse risk with diversification. There are plenty of mutual funds whose standard deviation and sharpe ratios exceed that of an ABT stock. I would have reduced my risk had I had 100% of my stock portfolio in one stock.

    Yet, prudent investing states that I diversify. But do 12 mutual funds with 300 holdings really reduce risk?

    I think asset classes reduce risk. Some small cap. some REITS and so on.

  • Report this Comment On June 22, 2009, at 4:35 PM, BillGator wrote:

    I find Rogers comments a bit surprising since his positions earlier this year included holding a number of different currencies, a large number of commodities, short the US financials, short Treasuries, long farmland...hardly a one basket bet.

    Also his commodity index is the most diversified commodity index out there...Compare RJI to DJP or GSG etc. So these comments by Rogers do not appear to be in-line with his actions. My guess, as others have implied, is that his words were taken somewhat out of context and he intended to make a point against over diversification.

  • Report this Comment On June 22, 2009, at 5:48 PM, DownConverter11G wrote:

    I also agree and a further comment, hate to mention it due to very "Un-American" thought, but Mr. Soros stated to the public on some radio or tv show a few years ago that it was his absolute intention to "bring this country to its knees!".. Not sure what the whole conversation was about, but why would any U.S. citizen say such a thing, in a serious, determined manner? Hopefully he cannot manipulate the market per his comments,,,,,!

  • Report this Comment On June 22, 2009, at 6:27 PM, jbrt wrote:

    hmmmm...... sounds like a good trap , especially for those whose employers will no longer contributing into their 401K's , remember one thing you can't go broke by not investing but by investing you can go broke . Think Twice and do YOUR OWN RESEARCH , for it is then you will only be able to blame yourself . No Research = NO INVEST ! , its YOUR money , not the advisors or the " brokers " , get it " broke "

  • Report this Comment On June 22, 2009, at 8:34 PM, paulbeam wrote:

    To the comment above about anti-diversificationists (how's that for a word?) shoving their opinion down everyone's throat -- HAH, that's rich -- it's the other way around. Anyhow, to refute the author of this article further, I guess in his non-legendary way he didn't realize that he's also gainsaying Buffet *and* Munger. To wit: "Wide diversification is only required when investors do not know what they are doing." (Buffet; and OK it doesn't exactly refute). "We don't believe that markets are totally efficient and we don't believe that widespread diversification will yield a good result. We believe almost all good investments will involve relatively low diversification." (Munger; from a Motley Fool article by Whitney Tilson 7May04). Hah. I also believe Munger said that a concentrated portfolio is how you get rich, and a diversified portfolio is how you keep from getting poor (I'm sure I'm wrong on the exact words, but that was the sentiment). In fact, according to "Contrarian Value Investing", both Peter Lynch and Munger are famous "concentrators" (not the mental kind). That despite their supposed diversified holdings, that their great successes came in just a few large bets.

  • Report this Comment On June 22, 2009, at 8:51 PM, BuyLowSellNever wrote:

    Andrew Carnegie said almost exactly the same thing more than 100 years ago:

    "Put all your eggs in one basket and then watch that basket. Do not scatter your shot. [T]he great successes of life are made by concentration."

  • Report this Comment On June 22, 2009, at 11:20 PM, eekthecat wrote:

    "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."

    I have to point out that Soros became a few billion dollars richer over these same years.

  • Report this Comment On June 23, 2009, at 2:33 PM, JtHExperimental wrote:

    The problem that the anti-diversificationists make is that they assume by only having a few holdings, they are not "diversified". This is not true. If I buy 20 microcap companies, I am likely less "diversified" than someone who holds stock only in GE.

    For all intents and purposes, the 100+ stock portfolio I manage is less diversified than Warren Buffett's "non diversified" portfolio. People, for whatever reason, do not analyze their stock holdings as individual businesses that have wide and varied operations oftentimes.

    Putting all your eggs in one basket can work, but its risky. There's such thing as smart diversification, just as there is such thing as diversification-that-performs-exactly-in-line-with-the-market.

  • Report this Comment On June 23, 2009, at 5:27 PM, TMFBent wrote:

    "Put all your eggs in one basket and then watch that basket. Do not scatter your shot. [T]he great successes of life are made by concentration."

    Also the greatest failures. It's just that the successes get remembered, and the failures, not so much. In other words, there are no paintings for those sailors who prayed for a miracle during the storm, but went to the bottom of the sea anyway.

    Sj

  • Report this Comment On June 24, 2009, at 2:27 PM, Netteligent09 wrote:

    GE and Motorola have so many small operations. They should spin them off and focus on core operations. Markket is not good I would not touch them until 2010.

  • Report this Comment On June 25, 2009, at 3:09 PM, Jeff2009 wrote:

    Nick, I hope you are an economist and not a writer. Although your points may be valid, the writing is terrible and the title stinks. The article has nothing to do with George Soros at all. In fact, you seem to be suggesting that Mr. Rogers is pulling Mr. Soros' strings and he is somehow complicit in Mr. Rogers' statement.

  • Report this Comment On June 26, 2009, at 4:31 PM, 3rdGrader wrote:

    Peter Lynch, of the Magellean Fund, recommends in his book to have no more than 5 stocks in your portfolio. By law, his fund could not contain more than 5% of any one equity.

  • Report this Comment On July 08, 2009, at 5:29 PM, silverminer wrote:

    For a counterpoint to the above perspective, as well as a rebuttal of its interpretation of Rogers' counsel, please read this:

    http://www.fool.com/investing/international/2009/07/07/consi...

    Fool on!

  • Report this Comment On July 30, 2009, at 4:40 PM, ltangel wrote:

    the hun -

    can you list what you are invested in/ and what has been you raverage return for say the last ten years?

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