The common advice from financial advisers and brokers today is to “diversify, diversify, and diversify” your investments.

I can’t think of a dumber strategy.

Have you ever wondered why these advisers and brokers recommend to “diversify.”  I know that common sense doesn’t mean much nowadays.  So I won’t answer that question directly.  In fact, individuals smarter than me and more experienced than me have answered it better.  Warren Buffett has actually answered it himself:

“Diversification is protection against ignorance.”

Investing To Lose

The very definition of diversity in investments is to balance your portfolio defensively by dividing your money among securities in different industries and classes so that gains in one area hedge against losses in other areas.  In other words, you have no control over your investments in stocks and mutual funds.  Neither does your adviser or broker.  Thus, because neither of you have any control whatsoever, they recommend that you not put your eggs in one basket and, instead, protect yourself against losses by spreading your money across different investments.

That sounds like investing to LOSE. 

When you diversify across different industries and classes of stocks, you’re simply hedging against the fact that you have no control over how your money performs.  Diversification is required when you do not have control.

You may think that that method of investing is “safe,” but all it does are two things:

1) It prohibits you from making any significant gains (i.e., you won’t get rich).

2) It doesn’t protect you from massive losses.

That doesn’t sound like a winning strategy.  In fact, it’s a loser.  And anyone who has ever watched sports (particularly football or basketball) will tell you that the best defense is a good offense.

Investing to Win

Let’s look at what Warren Buffett does when he invests.  Does he diversify?

No. 

Buffett doesn’t diversify because it doesn’t give him any control.  Investors like Buffett invest for control.  Thus, when Berkshire Hathaway invests in another company, Buffett buys either all of the business or a controlling share of the business.

He researches the company.  He evaluates its product.  He looks at its long-term stability.  He analyzes every significant aspect of its business and then determines whether it is worthy of an “all in” investment.  Buffett identifies winners, and he casts his lot with them and invests to win.

He doesn’t diversify.  He focuses on one company or one investment vehicle, and he follows that course until he is successful.  When you do that, you don’t need any hedges.  By informing yourself of the investment, you’ve provided your own hedge (i.e., education).  You have also given yourself control, which allows you to shun the “diversify, diversify, diversify” mentality that plagues passive investors.

In the end, this recipe (investing for control without diversifying) breeds success . . . and wealth.

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