08/02/2011 – On the Docket: The Case Against Diversification

* * * * *

Excerpt taken from Prechter’s
Perspective, originally published 2002, re-published
2004

Question: In recent years, mainstream experts have
made the ideas of “buy and hold” and diversification
almost synonymous with investing. What about diversification?
Now it is nearly universally held that risk is reduced through
acquisition of a broad-based portfolio of any imaginable
investment category. Where do you stand on this idea?

Bob Prechter: Diversification for its own
sake means you don’t know what you’re doing. If
that is true, you might as well hold Treasury bills or a savings
account. My opinion on this question is black and white, because
the whole purpose of being a market speculator is to identify
trends and make money with them. The proper approach is to
take everything you can out of anticipated trends, using indicators
that help you do that. Those times you make a mistake will
be made up many times over by the successful investments you
make. Some people say that is the purpose of diversification,
that the winners will overcome the losers. But that stance
requires the opinion that most investment vehicles ultimately
go up from any entry point. That is not true, and is an opinion
typically held late in a period when it has been true. So ironically,
poor timing is often the thing that kills people who claim
to ignore timing.

Sometimes the correct approach will lead to a diversified portfolio.
There are times I have been long U.S. stocks, short bonds,
short the Nikkei, and long something else. Other times, I’ve
kept a very concentrated market position. My advice from mid-1984
to October 2, 1987, for instance, was to remain 100% invested
in the U.S. stock market. During the bull market, I raised
the stop-loss at each point along the wave structure where
I could identify definite points of support. If I was wrong,
investors would have been out of their positions. The potential
was five times greater on the upside than the risk was on the
downside, and five times greater in the stock market than any
other area. Twice recently, in 1993 and 1995, I have had big
positions in precious metals mining stocks when they appeared
to me to be the only game in town. In 1993, it worked great,
and they gained 100% in ten months. Diversification would have
eliminated the profit. And every so often, an across-the-board
deflation smashes all investments at once, and the person who
has all his eggs in one basket, in this case cash, stays whole
while everyone else gets killed.

* * * * *

Excerpt from The Elliott Wave Theorist,
April 29, 1994

It is repeated daily that “global diversification” is
self evidently an intelligent approach to investing. In brief,
goes the line, an investor should not restrict himself to domestic
stocks and bonds but also buy stocks and bonds of as many other
countries as possible to “spread the risk” and
ensure safety. Diversification is a tactic always touted at
the end of global bull markets. Without years of a bull market
to provide psychological comfort, this apparently self evident
truth would not even be considered. No one was making this
case at the 1974 low. During the craze for collectible coins,
were you helped in owning rare coins of England, Spain, Japan
and Malaysia? Or were you that much more hopelessly stuck when
the bear market hit?

The Elliott Wave Theorist‘s position
has been that successful investing requires one thing: anticipating
successful investments, which requires that one must have a
method of choosing them. Sometimes that means holding many
investments, sometimes few. Recommending diversification so
that novices can reduce risk is like recommending that novice
skydivers strap a pillow to their backsides to “reduce
risk.” Wouldn’t it be more helpful to
advise them to avoid skydiving until they have learned all
about it? Novices should not be investing; they should be saving,
which means acting to protect their principal, not to generate
a return when they don’t
know how.

For the knowledgeable investor, diversification for its own
sake merely reduces profits. Therefore, anyone championing
investment diversification for the sake of safety and no other
reason has no method for choosing investments, no method of
forming a market opinion, and should not be in the money management
business. Ironically yet necessarily given today’s conviction
about diversification, the deflationary trend that will soon
become monolithic will devastate nearly all financial assets
except cash. If you want to diversify, buy some 6-month Treasury
bills along with your 3-month ones.

Want
More Reasons Why Diversification Should be Diverted from
your Portfolio? Get our FREE report that explains
the holes in the diversification argument. All you have
to do is sign up as one of our Club EWI members. It’s free,
and it will give you access to more than this diversification
report. Follow
this link to instantly download this special free report,
Death to Diversification – What it Means for Your
Investment Strategy.