Investing Greats Use Many Styles, But There's One Concept They All Agree On
Comments from the world's greatest investors go against conventional wisdom on a widely held belief. Here's how to apply this important lesson to your own portfolio.
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Stanley Druckenmiller, Warren Buffett, George Soros, Charlie Munger, William J O'Neil, and Jessie Livermore are considered some of the greatest investors in the stock market.
Although the approach to the market used by these legends differs and their styles vary, they also share some similarities. They are all quick to admit mistakes and have strict rules about investment management, but they also share one core piece of advice.
Let's take a look at some comments from each:
Charlie Munger —"The wise ones bet heavily when the world offers them that opportunity. They bet big when they have the odds. And the rest of the time, they don't. It's just that simple."
Stanley Druckenmiller —"I strongly believe the only way to make long-term returns in our business that are superior is by being a pig. I think diversification and all the stuff they're teaching at business school today is probably the most misguided concept everywhere."
William J. O'Neil — "Wide diversification is nothing but a hedge against lack of knowledge."
George Soros, when Druckenmiller wanted to put 100% of their net worth into a trade to short the British pound: "That is the most ridiculous use of money management I ever heard. What you described is an incredible one-way bet. We should have 200 percent of our net worth in this trade, not 100 percent. Do you know how often something like this comes around?"
Jesse Livermore — "Only make a big move, a real big plunge, when a majority of factors are in your favor."
Warren Buffett — "Diversification is a protection against ignorance. It makes very little sense for those who know what they're doing. We believe that a policy of portfolio concentration may well decrease risk if it raises, as it should, both the intensity with which an investor thinks about a business and the comfort level he must feel with its economic characteristics before buying into it."
"There's a temptation to dabble — particularly during bull markets — and in stocks, it's so easy. It's easier now than ever because you can do it online. You know, you just click it in, and maybe it goes up a point, and you get excited about that, and you buy another one the next day, and so on. You can't make any money over time doing that. But if you had a punch card with only 20 punches, and you weren't going to get another one the rest of your life, you would think a long time before every investment decision — and you would make good ones, and you'd make big ones. And you probably wouldn't even use all 20 punches in your lifetime. But you wouldn't need to."
What is most interesting about these comments is that they are the opposite of conventional wisdom, which states that diversification is extremely important in order to reduce risk. One of the first things that most investors learn is that to control risk, you have to hold many stocks and not let any position become too large. The ultimate manifestation of this advice is buying index funds, which is the ultimate level of diversification. Of course, you are never going to beat the market if you hold index funds, but you won't underperform either.
The investing greats disagree with the conventional wisdom about diversification. They believe that the best way to handle risk is by superior stock selection. The best protection is to do your homework, understand everything you can about a stock, and then watch it very carefully.
Most investors spend far too much time and energy on mediocre stocks that will never be huge winners. They have an itch for action and a lack of patience. When a favorite stock experiences an inevitable period of weakness, they are quick to give up on it and move on to something else.
The typical investor doesn't do a very good job of determining whether poor price action is because something fundamental has changed or if it is just market conditions. The best way to deal with this issue is to understand the fundamentals of the stocks you own and be aware of how overall market conditions impact the stocks you favor.
Last week I discussed how I deal with this issue by trading my favorite stocks in multiple time frames. I will hold some stocks for years but also aggressively trade them in extremely short time frames. Those are the ones that I want to have in size when market conditions are favorable.
The lesson here is obvious: If you want to produce exceptional gains, then you need to hold very large positions in the very best stocks. The theory is indisputable, but its application is the challenge we face.
At the time of publication, Rev Shark had no positions in any securities mentioned.
