Diversifying Into Crap

Background: I manage what I call the GeoDon Fund, a portfolio of stocks that my grandfather George put together a long, long, time ago.  I inherited a portion of the “fund” from my mother in 2010.  The portfolio had been basically untouched for over 35 years and I have attempted to clean up, diversify and “modernize” the holdings based on the original investing principles George followed.

Scene: It’s Saturday morning and I’m reviewing the GeoDon Fund on my computer, when the ghost of George suddenly appears.

Don: George! What are you doing here?

George: I see you are reviewing our fund and I wanted to see how you are doing.

Don: The fund is going very well.  Look at these winners!

George: Are you following my rules?

Don: Of course I am.  Look at how I have diversified the fund and spread the risk.

George:  What about these stocks?

Don: Ah, these three were not good choices, but I diversified and didn’t put much money in any of them.

George: Diversification doesn’t work very well if you diversify into crap.  You just get three flavors of crap instead of one. And this dog, what does this company do?

Don: This is a commodity company.

George: Commodities?  That’s risky business, my boy. This doesn’t fit with the rest of the portfolio.

Don: I know it’s not exactly a blue chip, but it had potential.

George: No it’s not a blue chip. In fact it looks more like a cow chip! Why on earth did you buy stock in this company?

Don: Well it had a high dividend with significant growth potential.  It was a no brainer.

George: I can see how someone with no brain would buy this stock.  Son, chasing this type of stock is like chasing skirts; you may have some fun for a while but it never ends well.

Don: Hey, it’s not my fault!  The company lied and said the dividend was very safe and future sales looked strong.

George: Unfortunately it is totally your fault for believing that garbage.  That’s why you stick with the blue chips and quality firms.  Those companies have established integrity over time.  Why did the stock drop so fast?

Don: The company cut the dividend by 76% and then announced earnings were weak and would get worse.  All the big mutual funds dumped their holdings and the stock tanked.  I read that when a company deceives the market, mutual funds dump it because they can never trust the company again.

George: So did you do your own research on this company?

Don: No, we have this great thing called the Internet.  On the Internet, all these investment gurus said the stock was great, so I bought it.

George: Did any of these so called “experts” actually buy any of this stock?

Don: I don’t know.  I’m not sure that they are allowed to.

George: So these guys are not suffering a bit over this and you are left holding …..

Don:  A turd. The GeoDon Fund now has a turd.

George: How many turds?

My cat makes investments too!

Don: Three turds, I made the same mistake with three different companies. They all lied and I bought their stock.  The good news is that have some capital losses as a tax write off!

George:  Oh that’s nice.  I never had any capital loses to write off when I managed the fund.  So what have you learned from this experience?

Don: Don’t worry George, I have learned my lesson.  I am going to stick to the original principles of investing in strong, established, manufacturing firms with an emphasis in the healthcare, energy and transportation sectors.

George: That’s my boy.  Uh, what did this “lesson” cost you?

Unfortunately, you can't polish a turd

Don: The three turds are down about $6,500.

George: The classes in this school are very expensive, aren’t they?

Don: Yes, they are.  That’s why it won’t happen again soon.  I am going to stick to the original strategy for the fund and only buy stocks that fit with this philosophy.

(And with this George departs, his mission accomplished, for now)