Posted by on Sep 14, 2017 in Articles & Advice, Blog, Featured, Posts |

By Jason Zweig  |  Sept. 14, 2017 9:20 p.m. ET

Image credit: “Egg Basket,” early 20th century, The Valentine Collection (Google Art Project)

In February 2000, a financial advisor named Bob Markman* wrote an article that got a huge amount of attention online. Called “A Whole Lot of Bull*#%!” (that’s how the original was spelled) and published by Worth magazine, the article attacked the idea of diversification, arguing that any money put into currently underperforming investments was money wasted. Internet and other technology stocks had been so hot for so long that nothing else was worth owning, Markman argued. He was far from alone in saying that.

Markman and I exchanged long emails and even longer letters (that’s how people communicated in those Neolithic days), but the “debate” boiled down to one point: Can the typical investor predict the future with precision, or not? Markman insisted the answer was yes. I felt then, as I still do, that the answer was no.

In Markman’s defense, there is a case to be made that if you have inside knowledge or superior analytical ability, then you should bet most or all of your money to capitalize on it. Warren Buffett and Charlie Munger have long argued exactly that. If you are as analytically brilliant as Buffett or Munger, diversification will lower your returns. The rest of us, however, should have much less courage about our convictions. And inside knowledge or superior analytical ability are best applied to individual securities, not to broad market views.

I wrote the post below in response to a question a reader emailed me. I’m posting it here partly for its historical interest, but more importantly as a reminder that people tend to believe crazier and crazier things as markets get overheated — and that such ideas can gain a crescendo of credence and popularity as markets crest. The Internet stock bubble began to burst only six weeks after my piece below was originally posted online. The growth-oriented tech stocks that Markman had claimed were the only assets worth owning went on to lose at least 80% of their value, while value stocks, international stocks and bonds overall did extremely well.

My interaction with Markman, which he insisted on calling a “debate,” taught me that some people will cling to a belief as desperately if it were a life preserver in a stormy ocean: No matter what logic or evidence you present, they will never let go.

But, as the biologist Sir Peter Medawar wrote in his wonderful little book Advice to a Young Scientist, “the intensity of the conviction that a hypothesis is true has no bearing on whether it is true or not.” Investors must always put aside the passion with which someone is advocating an idea and, instead, get answers to a few simple questions: Can I see your data? How far back does it go? Why does this idea work? If you’re investing on the basis of this idea, who are you buying from — and why are they selling to you?

Diversification Overrated? Not a Chance!, Jan. 26, 2000

Dear Jason, 
I am a somewhat knowledgeable but unsophisticated investor and would like to see your critique on the basic tenets of the article, “A Whole Lot of Bull*#%!,” by Robert Markman, in the February issue of Worth Magazine. The article made sense to me but so do many articles written by financial wordsmiths. 
Ed Roy

Dear Ed,

There is a fair amount of sense in what Markman says but there’s also a boatload of bunk.

Markman’s argument boils down to these four points:

1.) Diversification doesn’t do what it’s supposed to.

2.) Small stocks don’t perform better than big ones.

3.) Foreign stocks are not worth owning.

4.) Volatility, or short-term price fluctuation, is a poor measure of risk.

I’ve got no problem with Markman’s even-numbered contentions. But his odd ones are as odd as odd can be.

Yes, if you’d put all your portfolio into the S&P 500 a couple years ago, or even into a single stock like Qualcomm or CMGI, you’d have humiliated anybody who had prudently spread a portfolio across a broader range of U.S. and foreign stocks and bonds and cash.

But there’s nothing new about that. A diversified portfolio always has, and always will, underperform the hottest investment of the moment.

For anyone with a sustainable ability to identify the hottest investment of the moment, diversification is a mistake. But if you really believe you’ve got that ability, you’re not just mistaken. You need to be hauled off in a straitjacket to the Institute for the Treatment of Investment Insanity.

Bob Markman is convinced that big technology companies and giant U.S. growth stocks are going to dominate the global financial markets for the next 20 years, and he’s wagering nearly all his clients’ money on it. He calls that a “sure bet.”

But when it comes to investing, there’s only one sure bet: that sure bets don’t exist. Back in 1896, Charles Henry Dow included American Cotton Oil Corp., American Sugar Refining Co., Distilling & Cattle Feeding Co., Laclede Gas Light Co. and U.S. Leather Co. in his brand-new Dow Jones Industrial Average. All the Markmans of the McKinley era were convinced that these outfits were a sure bet to remain among the greatest growth companies in the world; yet today they’re so obscure Alex Trebek would refuse to use them in a Final Jeopardy! question. For all we know, a future generation of investors will think Microsoft must have been a manufacturer of upholstered doll furniture.

Abraham Lincoln liked to tell the story of a Middle Eastern ruler who asked his wise men to invent a statement that would be true in every place and at every time, no matter what happened. After mulling it over, they answered: “And this, too, shall pass away.” Sure, big U.S. growth stocks and tech companies pulverized everything in their path last year (and did darn well for a few years before that, too). But this, too, shall pass away. It must — unless you believe in a future world that has no industries except technology and no national economies except our own. That’s why it always makes sense to own foreign stocks and value stocks, regardless of their recent returns.

And Markman’s boast that his funds have beaten the market since he threw diversification out the window is pretty hollow. A one-year period is way too short to prove that Markman is right.

In any case, Markman defines being “right” the wrong way. To see why, let’s imagine that you and I have been next-door neighbors our entire lives. Every year, you’ve paid roughly $1,000 for homeowner’s insurance — while I have defiantly refused to insure my house. After 25 years, your house hasn’t burned down, gotten crushed by a falling tree or been munched into dust by a swarm of termites. But neither has mine, so I lean across the picket fence and holler, “Hey Ed, you idiot! You wasted $25,000 on insuring yourself against risks that never even happened. And I never spent a penny. I told you I’d be proven right!” And here’s what you’d answer: “Jason, you’re the idiot, not me. I made a good decision, not a bad one. And you’re not right — you’re just lucky.”

Likewise, if Markman happens to beat the market by putting nearly all his clients’ eggs in one basket, will he be proven right — or just lucky?


* A sad footnote: Although I disagreed with him on just about everything, I liked Markman personally. Years later it turned out that he had been running a Ponzi scheme; he committed suicide in 2010.



For further reading:


Chapter 20, “‘Margin of Safety’ as the Central Concept of Investment,” in The Intelligent Investor

A Fireside Chat With Charlie Munger

False Profits

Data Mining Isn’t a Good Bet For Stock-Market Predictions

The Promise (And Peril) of Going Big in the Stock Market

A (Long) Chat with Peter L. Bernstein

Lesson From Buffett: Doubt Yourself

I Don’t Know, and I Don’t Care

Tren Griffin, blog: “Charlie Munger on Investment Concentration versus Diversification

Mathematicians Against Fraudulent Financial and Investment Advice (MAFFIA)