A.I.M. Users Bulletin Board

[Conrad]

Hi Undertakr,

You are absolutely right on your statement on diversification and the statement of Warren Buffet hits the nail on the head too:

Diversification is a protection against ignorance. (It) makes very little sense for those who know what they're doing.

In my book The Vortex Method (1998 revised 2002, in Dutch) I more or less say the same thing except I addressed the ignorance(or deviousness) of the financial advisers that would promise their clients a 6 % yield while they would expect to get 8%(Client happy as a pig in shit(most of the time) and will be bringing in more money to get managed to get 8%) . . . Not to mention the Money Manager being happy too for the big fee he is charging for his ignorance). I argued that with (self)-selecting of a small number of high yielding funds(takes work) it would be relatively easy to get typically 20 to 50% yield(or more).

With respect to Risk/Reward issue I exposed the erroneous notion that high yields are to be had from consistently investing in high risk investments. Specifically I argued that high yields are the result of investing in stocks that are intrinsically low risk stocks, as well as intrinsically being good performers. I did not say that finding such stocks is easy, but I referred to Warren Buffet in this argument, more or less this way:

Warren Buffet is one of the best investors in the world not because he is stuffing his money in high risk companies but simply because he has a nose for low risk enterprises that are good performers to boot, or have the potential to be terrific performers with a little managing of the management.

What it comes down to is selecting only winners as a goal. The fact that one wants to select more than one winner is, of course, also a sort of diversification but one of completely different sort. In this type of diversification the stock selection comes first and is the most important thing, and then after that it will be a good thing to diversify the amount of the investments so that the best performer gets a bit more of the dough and that the liquidities get the highest interest possible.

This is the type of diversification that Aptus is talking about: picking stocks and allocating assets via the MPT is a smart sort of diversification because the underlying assumption is that the investor is already a smart investor. If you select 10 companies that will go broke in the next 4 months the MPT approach will not help one iota. For mediocre stocks the MPT may reduce the losses a bit, or marginally increase intrinsically low yields.

Essentially most of us(not the stampeding herd we buy from) will agree that investing blindly in 10 stocks without knowing anything about them is the worst thing that one can do: With a bit of luck he will pick 10 losers . . . the luck being on the seller's side . One might as well go to the horse races without knowing anything about the horses that are in the race. One might as well go sailing: that way you get rid of your money faster than investing in Enrons and the like, but at least you might have a bundle of fun.

One more thing on risk(already discussed long ago) is the problem that the real risk attached to an investment is usually completely hidden to the market at large(Enron types) and that the risk people usually kick around in their discussions is a statistical risk based on published price histories. In this sense volatile stocks are usually interpreted as high risk stocks while I claim that such stocks could have very low intrinsic risk instead. A robust solid company could be subjected to specific market factors that give it a volatile character. Such stocks are the gems in the market and especially good for the Vortex Method and for AIMing generally.

In this sense diversification of multiple volatile high yield stocks in an AIM portfolio is also a smart thing to do, especially if the correlation is such that half of the stocks go up while the other half goes down. In this case one would not need any cash at all.

I suppose if I could convince all readers that investing in risky ventures is a bad investment policy then I would be pleased. I am an expert on this: I lost my house on a high risk engineering venture. . . Some people do not like to be converted. . . so it seems.