This is a guest post by Tony Chou, who posts his thoughts on The Investorz Blog.
Personally, I believe in simplicity. Now before I start talking about why simplicity is beneficial when investing, let me go off topic for a while.
Is Simplicity The Key To Success?
What’s better? Complicated, or simple?
Let’s look at things from a corporate point of view. A good example would be Apple. When Steve Jobs came back from Apple, the first thing he did was streamline and cut down the number of products Apple made. Apple, back then, was making several different products, none of which were spectacular. Steve Jobs noticed this, and drew a simple diagram back in 1997 that he showed to the rest of the company.
These 4 products resulted in Apple making a huge comeback. If you look at modern day Apple products, what makes them so attractive? Yes, they’re sleek and sexy, but most of all, simple to use. Simplicity is key. What would happen if Apple started branching off into too many different markets? None of the products they make will be better than their competitors. Apple keeps their product line simple and small for a reason, which is to spend all their energy into creating one or two dazzling product(s). To this day, Apple only has two basic products lines. The iPod touch, which branches off into things like the iPad (a bigger iPod touch) and the iPhone (an iPod touch with phone capabilities), and their Macs.
Have you ever seen a company try to do everything, and succeed at most of what they’re trying to do? No. But I have seen companies that try to do everything, but end up going bankrupt.
What This Has To Do With Investing
From this, two thoughts entered my mind:
- Going in too many directions at once? You may not being going anywhere: Don’t buy companies (stocks) that try to do too many different things all at the same time! I know a lot of people preach diversification, because if a company doesn’t diversify, then it’s far too simple for them to be killed by competitors. The contrary is true! Because a company focuses on only one or two main products, they’ll make their product so good that competitors can’t catch up! Take Google for example (no offense to those who are invested in Google). 99% of their revenue comes from one product – advertising derived from search. But only 50% of their employees are working on their search engine (and the number is dropping every month). Am I seeing something odd here? Fire the other 50% and focus on what you do best – search! Cut out what’s unprofitable, and relentlessly work on your key product (that’s what Steve Jobs did when he went back to Apple). I’m almost 99% sure that one day, Google will go bankrupt because they tried to diversify into too many markets. Even Larry Page (Google CEO) said that Google’s goal is to be the hub of the entire tech world. Fat chance. So if you notice a company expanding into too many markets, take caution. Success breeds hubris, which results in the inevitable downfall of the mighty.
- Concentrated Investing is Key: I know this kind of sounds like I’m repeating myself, but that’s okay. I’m a huge fan of investing in one or two stocks or ETFs (concentrated investing). I’ve discussed before how small, full time investors can generate better returns (percentage wise) than big investors simply because they are small. They can plow all their money into one market, one investment, and focus the hell out of that market. The big investors can’t do this, because their portfolio is too large that they need to spread their money and attention over multiple markets. I’m not saying not to diversify your money into multiple baskets. But simply put, you do not have the time nor energy to watch over multiple investments at once. So if you still want to diversify, I suggest buying (or shorting if you wish) a market index ETF. That way you’re focusing on one investment (the overall stock market), and still not putting all your eggs in one basket (there’s no way the entire index can go bankrupt).
Remember, simplicity is the ultimate sophistication (yes, I stole this quote from Jobs’ biography). Once you attain a certain amount of investment skill (personally, I’m nowhere close to that level, but I know some people who are), you’ll notice that everything in life follows the same, natural order. From nature to the economy to society to life; they all follow the same pattern. Every investor starts off knowing nothing. I started off not even knowing what a bull or bear market was (I thought it was something related to farming). As you improve as an investor, you accumulate more and more knowledge and information. This results in complexity, because you got all this knowledge in your head, much of which contradicts each other, and you don’t know what to do with this knowledge. Eventually, you’ll clear away all the information that doesn’t work, sort through the complexity, shed away everything that doesn’t work, and you’ll be left with something simple, but works beautifully.