Deworsification

Lights go out and I can't be saved
Tides that I tried to swim against
Have bought me down upon my knees
Oh I beg, I beg and plead
--Coldplay

Ever since Markowitz's (1952) pioneering work on portfolio theory, a core concept in the financial services industry has been diversification. Spread your money around to assets that aren't correlated in order to reduce risk.

While this theory is widely hailed as gospel, there are two arguments against diversification. As Jim Rodgers notes about midway thru this video, big money is rarely made using a diversification approach. Better to focus your bets on a limited number of superior ideas. Common wisdom says that it is unwise to put all eggs in one basket. An alternative approach would be to put all eggs in the basket, then watch the basket.

The other problem with diversification is that, during times of major leveraging and deleveraging, prices of all risky assets tend to move together. Mike Shedlock notes that the correlation has been particularly high during the deflationary wave of the last couple of years. When folks are leveraged, falling prices drive investors to sell assets in order to reduce risk and avoid margin calls. The selling tends to be indiscriminant--prices of nearly everything fall. Diversification does little to cushion the blow when folks are selling all that isn't nailed down.

Note also in Mike's missive how valuable the diversification myth has been for the financial services industry.

The shackles of diversification are unlikely to shed by the masses anytime soon, however, unless they take a more proactive approach in managing their money.

References

Markowitz, H. 1952. Portfolio selection. Journal of Finance, 7: 77-91.