I came across a quote by Jim Rogers in SmartMoney magazine yesterday that almost made me blow my chocolate milk out my nose when I read it. In this interview, Mr Rogers says:

“Diversification is something that stock brokers came up with to protect themselves, so they wouldn’t get sued. Henry Ford never diversified, Bill Gates didn’t diversify. The way to get rich is to put your eggs in one basket, but watch that basket very carefully. And make sure you have the right basket. You can go broke diversifying. Ask anyone who’s diversified in the last three years. They’ve lost money.”

I couldn’t believe that SmartMoney printed this quote without clarifying the dangerous implication therein.

Specifically, that more people have lost more money by not diversifying. Just ask yourself, who is engaging in the riskier behavior: The individual investor who’s put most of his money into 5 stocks, or the one who’s invested his money in 5 broad-based mutual funds? Both investors have full time careers that are not related to finance and take up too much of their time to allow them to become stock picking pros.

Clearly, there is a higher likelihood that the investor who’s chosen 5 stocks will lose more of his money that the investor who’d diversified.

The problem with all of this is that Jim Rogers is right.

Bill Gates and Henry Ford are bad examples, because the basket that they put all their money in was their business, and we’re talking about investing not being an entrepreneur.

But if you substitute someone like Warren Buffet in place of Gates, then you have a solid point. Warren Buffet does not diversify. He’s famous for concentrating his assets into relatively few holdings. But here’s where the analogy or the process breaks down – Warren Buffet knows what he’s doing. Warren Buffet makes investing his life. Warren Buffett knows how to fairly value a company and its stock, and he knows how to profit on the difference between the fair market value of a company and the current market value of its stock. Most individual investors are nowhere near Warren Buffet’s level of business and investing acumen. Many don’t even want to put the kind of effort in that is required to reach his level of expertise. And that’s fine – provided they don’t think they can still invest like him.

And that brings us full circle to the problem of SmartMoney not calling Jim Rogers on his quote.

The way to get rich is to put your eggs in one basket, but watch that basket very carefully. And make sure you have the right basket.

Most individual investors simply don’t know how to “make sure” they have the right basket over the long term.

I’m sure Rogers said it to get noticed, generate some buzz about himself and garner scandalous attention. That’s fine. But where is SmartMoney, or Business Week? Both publications interviewed him and neither felt the need to comment on his statement about diversification.

It’s a shame really, because the quote is only part of a much larger interview at BusinessWeek. I recommend reading the entire interview because he has some very interesting points to make about commodities and the Chinese and US economies.

I just wish the magazines would have provided some cautionary counterpoint to the controversial diversification quote.

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