Does the Investing Advice of a Billionaire Help Ordinary People?

A reader passed along this interesting interview from the Wall Street Journal with Mark Cuban. For those unfamiliar, Cuban is a billionaire who made a significant amount of his wealth in the early days of the internet era. His argument in this interview? Diversification is “for idiots.”

First of all, let’s talk about what diversification actually means.

Diversification means that you’re investing in a number of different things so that you’re not as badly affected if one of them falls. For example, when the stock market falls in price, that doesn’t mean that real estate will also fall.

So, let’s say you have half of your money in stocks and half of your money in real estate. If stocks fall 40% this year and real estate stays steady, you’ll only lose 20% of your money. Of course, on the other hand, if the stock market goes up 20% and real estate stays the same, then you will only gain 10%.

Okay, so let’s look at what Cuban is saying in this video.

His first suggestion for the average person is to pay off debts, particularly high interest ones. I completely agree. Interest on debt is just money flowing out of your pockets for nothing in return.

After that, he essentially recommends budgeting, which I also agree with. He points out that most people don’t bother with a formal budget, which is true, but then he goes on to recommend that people get a grip on what they’re spending around their house.

This is where things get interesting. Cuban’s next suggestion is that people have cash on hand – lots of it. He doesn’t really care that you’re “only” going to earn 1% in a savings account. What he cares about is opportunity.

Let’s say you’re saving up cash in your savings account and you’ve built up, say, $25,000. A friend of yours works in, say, biomedical research and he tells you that there’s a company that’s on the verge of a huge discovery. You could then take that $25,000 (or most of it) and invest it in that company.

If you have that $25,000 tied up in other things – real estate, stocks, that SUV in your driveway, your bigger-than-necessary house – you don’t have the ability to just grab that cash and invest. You can’t even do it if you wanted to.

This also makes sense to me, but only for people who are in a fairly secure financial situation – and that’s the problem. He even alludes to it a couple of times in the video.

Most people are not in a situation where they’re going to be financially sound if they lose most of their savings. People who don’t have millions in the bank can’t afford a giant risk.

For people in situations like Cuban, if they invest a million dollars and lose 90% of it, it’s not a big problem. They have other assets. If a couple who works hard to make $50,000 a year invests their $1 million in retirement savings into a single thing that loses 90%, that’s going to wreck their life. Risk works in a completely different way for the middle class and the poor than it does for the rich.

Cuban even makes this clear throughout the video – even though he says “diversification is for idiots,” he is never invested in just one thing. He talks about investing in this and investing in that at the same time. Cuban wouldn’t put a large percentage of his net worth into any one single investment. He might be making “huge” investments in specific things, but compared to his holdings and net worth as a whole, it’s still a pretty small slice.

After watching the whole video, I don’t think Cuban is against diversification, but against passive investing. He’s able to get strong returns on his money because (a) he spends a lot of time looking for opportunities, (b) he has enough cash sitting around to jump on those opportunities, and (c) he has enough other investments that he won’t be homeless if an opportunity fails.

That doesn’t necessarily match up with the situation of Joe and Jane Average. For one, they’re likely spending a lot of their time working in their career path rather than scouring the world for opportunities. They might be able to find time to do so in their spare time, but the vast majority of Americans aren’t in that situation.

Because of that lack of time, they have to come up with some sort of plan that will help them save enough for retirement. That’s the whole point of passive investing. Rather than trying to get a huge return on your money by studying and researching investments and opportunities, the focus instead is on matching the average for as little effort as possible. You won’t get insanely rich, but you won’t go broke, either.

I thoroughly encourage people who have their retirement plans taken care of, are free of debt, and still spend less than they earn to take the excess and hold it in an “opportunity” account. There’s nothing wrong with having cash sitting there until some great opportunity comes along, like a huge sale on something that you know you can flip (like a house or a collectible item).

However, most of us don’t have the time nor the risk tolerance to invest like Mark Cuban does. It makes sense to do things this way once you start accumulating a fair amount of money, but in an America where almost 3/4 of us live paycheck to paycheck and 80% of Americans aren’t saving enough for retirement, investing as though your lifestyle is secure isn’t the wisest idea.

Even given all of this, I completely agree with Cuban on the first steps. Get rid of your debt. Get a grip on your personal spending. If you can’t handle those things, all of the investment advice in the world is useless.

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