Lesson #4 of 7:
"Profit in any market with 'True Diversification' - Part 1"
From: Dan Murphy
Corona Del Mar, CA
We’re at the midpoint of our “one-man hedge fund” training it’s time to talk about something that might seem … obvious.
Diversification is important, right?
Everyone knows that …
Heck, even in kindergarten, the teacher tells the students …
“Don’t put all your eggs in one basket.”
And it’s good advice … so why don’t most people take it?
We see people like Jim Cramer preaching diversification.
But all he ever talks about are stocks.
Well, I’ve noticed something about stocks. I’m sure you have as well.
When a bear market hits … they all go down at once.
How’s that for diversification?
Thinking about this led me to an idea.
Quality of diversification is ultimately what separates the winners from the losers.
To understand this better, I want you to think about the market like a giant air mattress.
When a bear market hits, it’s like somebody steps on the section of the air mattress.
The air is pushed out, and that area deflates.
But the air doesn’t disappear.
It just gets transferred to another section.
If the section of the mattress representing stocks gets stepped on …
The price of stocks sink …
But the wealth they represent doesn’t just disappear. It’s pushed to another section.
Just like the air mattress.
Maybe it’s commodities, maybe it’s an overseas market or real estate.
Hedge funds make a lot of money by predicting which sector of the market money will flow into.
They position themselves to take advantage of this movement between markets. Siphoning off a little bit of wealth as it flows from one sector to another.
The problem retail investors and traders face is that it’s hard to know exactly which sector of the market the money is going to flow into.
Guess wrong, and you could lose money.
This often leads to them not even trying to profit off of this flow of money (spoiler alert: that’s a big mistake.)
Instead they end up falling victim to “false diversification.”
The 2 miss-steps most people take that lead to false diversification:
Thanks to the advice of some popular financial advisors, people tend to make these two mistakes. They lead to reduced returns, and vulnerability to market crashes.
- Most people Over-Diversify
- Most people Under-Diversify
That’s right, most people are both under-diversified and over-diversified at the same time! I explain fully down below.
When a portfolio is too diverse, it has no chance of beating the market.
If diversification means safety, a lot of it must be good, right?
Wrong!
It’s possible to over-diversify — at a certain point, your returns will start to match the market.
That is not good.
Our goal as investors and traders is to beat the market. Otherwise, we might as well have saved a lot of time (and brokerage fees) by buying one ETF pegged to the market.
The second big mistake people make is even scarier.
Diversifying in just one sector of the market leaves you vulnerable.
Here’s where the followers of Cramer (and other popular talking heads) are led astray.
They’re told to diversify, so they buy up a ton of different stocks. Probably to the point that they’re “over diversified.”
At the same time, their portfolio is shockingly concentrated.
You see, when you’re “over diversified” to the point that you’re matching the underlying asset class you can’t think of all your investments as separate entities.
Essentially these people have ended up investing in ONE THING.
Stocks.
(That doesn’t sound like a diverse portfolio to me.)
I bet you can guess what happens when a major bear market hits. Just like it did in march of 2020.
Everything falls through the floor at once.
Here’s where the “one-man hedge fund” model takes a lead.
When you design your one-man hedge fund you end up choosing investments more like… well a hedge fund.
Small selections of good assets, with proper inverse picks to hedge against them.
This allows us to take advantage of the flow of value from one market to another. While protecting ourselves. While avoiding the trap of over-diversification in ONE asset class (I’ll go more into this in tomorrow's lesson.)
To finish off today I want to talk about how the “one-man hedge fund” model takes things a step further than just copying the hedge fund model.
This technique allows you to experience the benefits of “true diversification.”
It all comes down to the “bucket” system we learned about in Lesson #2.
If we separate our portfolio into 3-5 buckets it’s almost like having our money invested in the same number of hedge funds.
(Hedge funds we know we can trust AND we know are working together… because we designed them ourselves)
It might be best if we return to that quote about diversification. The one we all learned in grade school.
“Don’t keep all your eggs in one basket.”
The kind of “false diversification” that the talking heads advocate for, where you just pick a bundle of different stocks … well, that isn’t multiple baskets at all.
It’s just one big basket, and when something happens to it, all those eggs are going to shatter …
The diversification the hedge funds have is like having three baskets of eggs, and juggling them.
Don’t get me wrong, they’re good jugglers and they clearly know what they’re doing.
But if you’re like me, you don’t want to learn to juggle… you just want to earn enough money trading. So that your family never has to worry and you can live the life you want.
In that case, the choice is clear …
The “true diversification” of a portfolio split into buckets is like having 4 baskets.
Each is protected by an AI anti-gravity field (that’s Portfolio Boss) choosing strategies, mitigating risk, and making sure your nest egg grows as large as possible.
That’s all I have time for today, but be sure to check back in tomorrow to see Part 2 of this lesson.
Where I’ll show you how it doesn’t take a full black swan event to blow your basket over …
And I’ll show you how a “one-man hedge fund” can become practically bulletproof against minor disturbances as well as true black swans. Using this concept of “true diversification.”