Cramer calls diversification “the only free lunch in this whole gosh-darned business.” Diversification prevents total portfolio melt downs. For example: recently I got squashed by the cyclical rotation out of oil and gas drilling. Sure, I’m still happily receiving my income from my drilling stocks but the capital value has been flushed down the toilet. Because I’m diversified, stocks in other sectors have increased to offset the decreases.
A vivid example of why we need diversification was the whole Enron fiasco. On his radio show, Cramer was being sympathetic to the people wiped out by Enron and this is what happened next…
“My wife, the Trading Goddess, happened to be listening. She called in and let me have it. Just took me apart. She said how dare I feel bad for people who had millions of dollars and then gave it back in the market. How dare I feel bad for people who weren’t smart enough to diversify and were so greedy as to not take the care to put their eggs in different baskets. I was just encouraging that kind of behavior for others when I could have been using their intellectual laziness and lack of knowledge about the value of diversification to drive home the point about how easily avoidable such heartbreak is. She was furious that I put the emphasis on the government’s screw up in not catching Enron earlier. Diversification, she said, assumes that the government will screw up and not protect us. It presumes that companies’ execs will at least let us down if not loot their own enterprises. When she was through with me, I said, Holy cow, I better appease the Trading Goddess and find a way to make diversification come alive on the show, pronto.”
As Mad Money viewers know, Cramer plays a game called “Am I Diversified?” He asks for the 5 biggest holdings and then judges whether it’s a diversified portfolio.
For diversification, I ask myself “do the stocks move together?” Diversified stocks don’t.
BTW…I enjoy that Cramer credits his wife, whom he affectionately calls The Trading Goddess, with most of his understanding of the market. It blows the myth of women not being great traders out of the water.
Comments (3)
Diversification lets you ride out the bumps and corrections in the market a lot better than trying to put all of your eggs in one basket.
But with that said I've heard people say that you're not going to make it big unless you go for it all. I'm not sure I subscribe to this myself but I'm just learning... and from what I've learned so far sometimes you really have to go for it.
Posted by Matt | January 10, 2007 9:24 PM
Posted on January 10, 2007 21:24
Matt - Diversification protects wealth. Concentration creates it.
Posted by Shaun | January 11, 2007 9:44 AM
Posted on January 11, 2007 09:44
Buffett says diversification is great if you don't know what you are doing. But you can do really well, without diversifying if you know as much as possible from a few companies that you invest in. Legendary fund manager Joel Greenblatt (who averaged 50% returns during his run at the Gotham Fund) invests in 5-8 companies at a time, sometimes having 30% in one stock.
If you know as much about the company as anyone except management, you will do well. Sorry to hear about your drilling stocks. I think they will turn up soon. I'm long on PTEN. I think the physics of natural gas drilling (twice as many rigs needed to get the same amount of gas as 10 years ago) will make these stocks do well despite the fact they have been down this year due to one of the warmest winters on the east coast in recorded history.
Posted by homeimprovementninja | January 11, 2007 10:27 AM
Posted on January 11, 2007 10:27