Diversification vs Concentration of Assets
In a previous post, I tackled Mark Cuban’s rather unique view on investing. And since in investing, as you might have heard or read before, going with the flow or bandwagon-ing can be very detrimental to your success, there was good reason to discuss one of the most unique advice I’ve ever heard.
And though I believe the article can stand on its own, I didn’t want to risk people mistaking the article for advice.
So in this article, I’m tackling what might be the most dangerous concept that was voiced in that article: Diversification vs Concentration of Assets
One of Mark Cuban’s main approach (and the one central to our topic) can be simply stated as: Diversification is for idiots; invest only in what you know.
It’s important to note that it’s one whole sentence. Because the second part (investing in what you know) is a common advice you hear. I wouldn’t buy or trade in gold because I don’t know the first thing about it. But I trade stocks because I do know something about it (not a lot, but something).
But the first, more controversial part (don’t diversify) is counter to common advice. Though risk is unavoidable, we should do what we can to protect ourselves.
So is this really good advice?
Well, on one hand, what Cuban said appears to have some real-life evidence to back it up. We’ve already mentioned an article published by Yahoo. The most relevant excerpt is highlighted below:
“Billionaires do not become billionaires by getting into a diversified
mutual fund or investing in an ETF or investing in the S&P Index
Fund,” Miller tells The Daily Ticker. “You get rich by building equity
in a very concentrated position that is typically one big company.”
But of course, not everyone is aiming to be a billionaire. Sure we’d take the money, but most of us would probably be more than satisfied with something like a hundred million, if not less.
Plus, as we’ve mentioned before, the necessity of taking risks makes diversification more important. The last thing we would want is to go “all-in” and lose.
But if we really analyze what he’s saying, this is where the second part of his approach comes in: invest only in what you know.
To us, or at least to me, at face value this just means if we know how to trade stocks, know one stock in particular, or trade foreign currencies we should just stick to that.
But at this point it’s very relevant to state that Cuban is an entrepreneur and actually identifies himself mainly as an entrepreneur. Not as an investor, CEO, chairman, or NBA owner.
And at this point it’s very enlightening to refer to “The Sure Thing” – an article Malcolm Gladwell wrote about another daring, risk-taking entrepreneur of yester-year: Ted Turner.
In summary: Ted Turner, embodying the image of an entrepreneur as a risk-taker, risks everything (mainly the profitable billboard empire he inherited) in acquiring a small, unknown, unprofitable, and incompetently-manned tv station. And, at least from the way he describes it, did so because he was bored and it would be “fun.” He was “attracted to the risk.”
But in his New Yorker article, Gladwell points out that Turner was more likely attracted to the lack of risk. He didn’t have to pay anything for the station – buying it with a share-swap. His billboard business at the time was so profitable it could just absorb the station’s losses. And he could actually advertise his station for free on his billboards.
What was risky was actually risk-free. It was just that he was the only one who saw it.
And as self-identified entrepreneur, that’s basically what Cuban is saying. Why waste time, effort and money on stuff that you aren’t sure will turn you a profit?
Hugely successful entrepreneurs take risks – but only when they know it will benefit them. They
don’t make their money by gambling; they make it by taking on a risk
that isn’t really a risk.
It’s much more lucrative to hold your cash, wait for the “sure thing” and then swing for the fences.
But is it a practical approach for ordinary folks like us?
Well, I personally believe it can be.
I haven’t been stock trading that long (1.5 years). And I certainly don’t know enough yet to intelligently pick “winning” stocks. But one day I randomly came across a stock and found out it had a 20% stock dividend.
It wasn’t cash, but it was the next best thing. And more importantly, being a dividend, it was a guaranteed 20% profit. The only risk was if the stock price went down. Amazingly, the stock was surprisingly stable. So I sold all my other stocks, which were only making 0-6% gains at the time, and went all-in the day before the ex-div date.
Sure, it was a big risk. But I figured that even if the stock went down 20%, I’d come out with only a 1-2% loss on my capital. But in contrast, the best case scenario had me making almost 20% (when accounting for fees and taxes) in one day as I could sell my holding the very next day and sell the stock dividends once I receive them.
In the end, I got extremely lucky. The stock actually went up a lot in value. So I ended up getting a 74% return after a month.
Of course, I readily admit I just got lucky. But I put myself in a position to get lucky by capitalizing big time on an opportunity.
And essentially, that’s what Cuban is really getting at. Sure, there’s a lot we don’t know. But it can be very rewarding to remain liquid while waiting for a great opportunity.
So what he is saying isn’t really to risk everything by not diversifying. What he’s getting at is to be even more cautious and stop betting on things until you see a sure thing.
Of course, that advise won’t fit every personality or situation. But it’s at least worth thinking about.
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