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:

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.