Market gurus like Jim Cramer preach the benefits of broad diversification, something I think is good for investors too: if your goal is to produce returns approximately equal to the market averages. In other words, if you believe in diversification, buy an index fund. If you don't want to simply buy and hold index funds, broad diversification is unlikely to make sense for you.
I recently found a good summary of why combining diversification with stock-picking is a bad idea from an unlikely source: Michael Konik's The Smart Money, a book about an elite sports bettor who gambles hundreds of thousands a day on football -- and wins. Here, he explains why the elite gamblers don't bet on more than a few games each week:
I'm sober enough about the difficulty of betting sports to realize that gambling on seven pro games in one weekend is the sign of a sucker. The linemakers just don't make that many mistakes on NFL football, where all the information is widely known to everyone in the universe.
It would be impossible to sum up the problem with diversification in the stock market any better. Generating greater returns without taking greater risk requires the investor to spot instances of market inefficiency -- the stock market equivalent of the linemakers making a mistake. And even the best investors in the world can't find enough market inefficiency to earn exceptional returns while owning a lot of stocks.
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Serious Money: Three stocks that beat the market
Closing Bell: The wishy-washy return to Q3 (AA, DDUP, EMC, DNDN, CVX, FSLR, GS)
Reader Comments (Page 1 of 1)
2-24-2008 @ 4:36PM
beanspants said...
sportsbook gambling is a pretty thin indictment of diversification, considering that the sportsbook gets to add in the 'spread' to pick against. if it were so difficult to pick games, they wouldn't need that.
and if the elite gamblers were so great, then they would only bet on one game per week. they are still diversifying with a 'few'.
consider that good diversification across the stock market only involves about 20 stocks out of let's say 500 good ones. that means good diversification= 20/500 = 4% of stocks.
There are only 16 or so football games per week, so to equal the 4% diversification of the stock market, you'd only bet on 1.4 games in 2 weeks worth of games or so.
Finally, the sports book is the equivelent of trading, not investing. One winner = one loser. Most traders pick a really small number of stocks to trade into and out of, so take Smart Money with a grain of salt.
2-24-2008 @ 11:55PM
Chris said...
Zac,
1) Pick up a textbook on corporate finance.
2) Develop an understanding for how diversification works. What I mean is figure out how it *really* works. Warning: some math required.
3) Come back to bloggingstocks.com and apologize for this post.
OF COURSE finding market inefficiencies is the path to riches. That is why everyone is trying to do exactly that. Ant THAT is what makes the market efficient.
BTW, if you read Cramer's "Real Money" book, I think you'll find that his stock picking strategy is more aligned with Konik's thoughts than you realize.
Chris
2-25-2008 @ 2:24PM
JW Stringer said...
I recommend all interested in sports betting check out http://pregame.com - it's a web site that really devotes itself to giving all tools, resources, adn information available to potential bettors to make sure they the utmost confidence in placing their bets.
Just my recommendation.........