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.
-- Jim Rogers
Diversification is a protection against ignorance. [It] makes very little sense for those who know what they are doing.
-- Warren Buffett
Two great investing minds, both telling us not to diversify. But are they right?
Diversification means buying unrelated companies -- even asset classes -- in your portfolio. Done properly, it will smooth your returns, protecting you from having your entire portfolio crash and burn if one industry goes bad. (See: Financials, c. 2008.)
And this is excellent advice. Up to a point.
Eggs and harems
Yes, Henry Ford probably didn't diversify. Bill Gates got megarich from Microsoft
On top of that, we don't usually have time to follow our investments that closely. I don't know about you, but I've got a day job.
You can go too far the other way, too, trying to get into every single industry and country out there. That's just as dangerous as owning a single stock, but in a different way. Buffett once said, speaking about over-diversification, "If you have a harem of 40 women, you never get to know any of them very well." And he's right. By not knowing what you are buying, you can end up buying horrible investments.
The happy medium
So what can we do instead? Not invest? That's not the answer. Recent turmoil and lower stock prices make investing right now particularly promising for those with a long-term outlook. But what to buy is the question.
There has to be some happy medium, one that gives you enough diversification for protection, but not enough that you have no idea what's in your portfolio. And there is.
It's called, "index plus a few."
This is a strategy where a large portion, even the majority, of your portfolio is in a low-cost, broad-market index fund, such as one that tracks the S&P 500 or the Wilshire 5000.
With the rest of your portfolio, you buy what you know, using your own knowledge and experience to give yourself an edge to beat the market.
Here's your edge
For instance, if you work in retail, you probably know all about inventory control and keeping expenses down and margins up. This gives you insight into how well cash is flowing through businesses such as McDonald's
Or maybe you're a doctor. If so, you're probably more likely to understand the problems and opportunities facing companies like medical-device maker Medtronic
Or, you could be like David Gardner, co-founder of The Motley Fool and co-advisor to the Motley Fool Stock Advisor service.
You see, David's a gamer. He loves games, be they board games, electronic games, or made up on the spot. From that love, he's gone on to study many companies that make and sell games, working out what makes them successful or not. And with that knowledge, he's recommended several of the best to Stock Advisor subscribers.
One of them is Activision Blizzard
Diversification can protect you if things go crazy in one or a few industries. But taking advantage of your own knowledge and insights gives you the edge to do better than the market. Index plus a few gives you the best of both worlds.
Stock Advisor can help on your journey. I've already shown you how David is using his gaming edge to help the service beat the market by 39 percentage points. And now is the time to join the fun. He and his brother, Tom, have just finished their popular six-month reviews of all their recommendations, so with a free 30-day trial you'll be able to get their latest thinking. There's no obligation. So give it a try.
Jim Mueller owns shares of Activision and Apple and has a beneficial interest in Microsoft. Apple and Activision are Stock Advisor recommendations. Home Depot, Microsoft, and Wal-Mart are all Inside Value choices. The Fool's disclosure policy likes it when you know such things.