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  • Writer's pictureIshfaaq Peerally

DON'T DIVERSIFY Your Portfolio ๐Ÿ›‘

Today is really a great day both for the market $SPX500 which is up by about 0.7% and for our portfolio. Our largest position, $DGE.L is having a terrific day being up by nearly 1%. $SWKS , our second largest holding is up by nearly 2%. The two $OIL stocks $CXO and $PE are doing great too. The only disappointment comes from $GME after $SNE announces that the new consoles will be available at a later date next year. I don't think that this is really a news for us to worry about. In fact, we should take the opportunity to buy some more shares of GameStop. It is always good to see the stock price of a company you're buying go down.

DON'T DIVERSIFY Your Portfolio ๐Ÿ›‘

Let's say you want to build a retirement portfolio. She's pretty smart and she tells you that almost nobody beats the market, so you should just invest in the S&P 500 $SPX500. You have a well diversified portfolio with 500 companies. It looks like a pretty good deal. After 40 years, you're ready for retirement and the market crashes by 50%. You lose 50% of all your investments. Where is the diversification now?

Mark Cuban says that diversification in for idiots and he's right. You may tell me that everybody says that you should not put all your eggs in one basket. But here's the problem with that. First, you cannot focus on only a few good companies and you just invest in many average companies. Also, when you invest in the S&P 500 index, you're buying high and selling low. Let's take for example if you invested in the index in the 1970s. The largest companies were then IBM $IBM , GE $GE , GM $GM . But today, these companies are not even in the top 10. You would have bought them when they were at a high price. Today, just 5 companies, Apple $AAPL , Microsoft $MSFT , Facebook $FB , Google $GOOG and Amazon $AMZN make up 40% of the Nasdaq100 $NSDQ100 . If you invest in this index today, you're buying these stocks when they are high. Maybe in the next decade, a smaller company will be number one on the index.

Some people will tell you that you should invest in what you know and put all your eggs in one basket and watch it closely. That's another advice people take too literally. They invest in the company where they work. If the company goes bankrupt, they lose their jobs and savings. If you are an $OIL engineer, you'll tend to buy oil stocks. If oil prices fall to $30 next year, you lose everything.

What should you do then? Listen to great investors. Warren Buffett said that diversification, as practiced generally, is protection against ignorance. But there is a right way to do it. Ray Dalio has the all-weather portfolio which is supposed to be stable and beat the market in the long-term. This is the best option for most defensive investors. As for enterprising investors, they should understand the secret of the all-weather portfolio. It's correlation. Let's say the oil and an oil stock such as ExxonMobil $XOM , they have a positive correlation with each other. When one goes up, the other goes up too. Gold $GOLD and the S&P 500 have a negative correlation. Diageo $DGE.L and the British Pound $GBPUSD has a negative correlation. But Diageo and the ExxonMobil are not correlated at all. The business of one doesn't depend on the business of the other. That's why the S&P 500 is not diversified. When Apple misses earnings and the stock price goes down, the stock of all the other tech company will go down too.

How to build the right portfolio? It depends on your financial situation, your risk tolerance and how much time you have to dedicate to researching stocks. If you can't put 40 hours per week into researching stocks, you should most probably not invest on your own. The best thing to do is invest in the All-weather portfolio. Now if you want to pick stocks. You need only 10-15 in your portfolio in industries with low correlation between each other.

You should of course, always look for stocks in industries which are at a great price. When you buy stocks, you're buying a business. Look for businesses all around the world. It is harder and harder to find stocks in the US and Europe. Somewhere in the world, there is a bear market right now. For example, Chinese stocks are not doing so great. But always look for the right company at the right price. Don't just buy Alibaba $BABA or Nio $NIO . Take advantage of workouts. I have a risk arbitrage workout on the Allergan $AGN - AbbVie $ABBV deal. This investment has no correlation with the rest of the market. Find some good baskets and put one or two good eggs in each one of them.

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