Mark Cuban, entrepreneur and part owner of the Dallas Mavericks, said in a Wall Street Journal interview he doesn’t believe the commonly given investment advice that diversifying your portfolio is a good approach for the average investor. Here’s what he had to say and the upsides and downsides of his approach.
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Mark Cuban on Diversification and ‘Buy and Hold’
Many financial advisors recommend that you diversify your portfolio to reduce risk. This means splitting your money into different investments that don’t usually all go up and down in value at the same time. That way, you don’t lose all your money if one of your investments fails spectacularly.
One of the most diversified ways to invest in the stock market is to buy an index fund that tracks a large range of companies, such as the S&P 500. The theory is that if you invest in a large chunk of the market at once, a single company failing doesn’t affect you that much.
Cuban disagrees. He told interviewer Alan Murray, “Diversification, that’s for idiots.” He argued that regular investors lack the knowledge or resources that a large hedge fund would have and don’t have the time to gain a deep understanding of many different investments. Because of this, he suggested focusing on just a few investments and learning as much as possible about them.
Cuban also expressed skepticism about the common “buy and hold” approach. Until you’re sure you want to commit to an investment, he suggested keeping your money in cash.
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The Risks of Trading
So what are the upsides and downsides of Cuban’s approach? The upside of focusing on just a few investments is that if you succeed in your research and timing and your chosen investments grow, you could make much higher returns. Your money wouldn’t be spread out over many other investments, so you would be able to take maximum advantage of that growth.
However, doing this right isn’t easy, and it may require quite a bit of luck. If you’re not buying and holding an investment long term, then you are, by definition, trading. When you trade a stock or other investment vehicle, there are some additional risks to consider.
Markets can go up and down unpredictably, and trying to time the market can result in heavy losses. Even if you know an investment inside and out, government interventions or other unexpected factors might change the playing field completely.
The Buy and Hold Approach
The advantage of buying and holding is that most markets generally go up in value over time. Even if you time your entry badly and your investment loses value after you buy it, as long as you don’t sell, you should get your money back — and more — with time.
Of course, this applies to the market, not the individual companies within it. The S&P 500 index recovered from the dot-com bubble of 2000 in around seven years, for example, but many of the individual companies that crashed never recovered.
Warren Buffett’s Opinion on Diversification
Warren Buffett, one of the most successful investors in history, actually somewhat agrees with Cuban, though he recommends diversification for the average investor. Buffett once said, “Diversification is protection against ignorance. It makes little sense if you know what you are doing.”
What this means is that for investors who are not experts in analyzing individual companies, spreading investments across various assets reduces the risk of significant losses if one investment performs poorly. Buffett believes that many people may not have the time or expertise to thoroughly evaluate every investment opportunity, so diversification is a good option for them.
However, if you really know what you’re doing, then carefully picking fewer investments can pay off.
Buffett often recommends that average investors put their money into low-cost index funds that track the broader market. However, his hedge fund, Berkshire Hathaway, does make significant investments in individual companies, like Apple and Coca-Cola.
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This article originally appeared on GOBankingRates.com: Mark Cuban’s Surprising Advice for Diversifying Beyond the Stock Market
