Mutual Funds do not outperform the market on a consistent basis because of two reasons:

1. Regulations which require them to maintain a minimum exposure to the market, and
2. Buy-and-hold (aka Buy-and-hope) fundamental analysis driven investment strategies

However, there are many hedge fund managers that do outperform the market CONSISTENTLY. I encourage you to read Michael Covel’s books, “Trend Following” and “The Complete Turtle Trader” for detailed records and strategies of Trend Following technical traders, this is the investment philosophy I follow, and the most balanced and objective in my opinion.

I believe you should never risk what you absolutely cannot afford to lose. People need to stop thinking about getting rich quick, and think about how to consistently grow their assets by taking calculated risk – focusing on the process and not the result, but using the result to optimize the process. You mentioned that Leverage is a double-edged sword, so is Diversification. It not only protects your assets from risk, but it dilutes their potential gains.

My personal philosophy is that of Robert Kiyosaki’s. Every one says “Don’t put all your eggs in one basket.” But, you shouldn’t put a few eggs in many baskets either, rather, you must place many eggs in a few baskets. You have to find that optimal, focused level of diversification depending on many factors including investment goals, risk aversion, and proper risk analysis of the asset classes in question.

Thanks for a great blog!

Cheers,
Muaad

If you think you can identify the good ones from the bad, with 100% certainty, then you will probably go down in history as the only prescient guy. No one has ever been able to consistently make such identification with 100% certainty. If you can do anything with certainty for even 10 seconds, and prove such, you can borrow 10 trillion tomorrow or as much as the market liquidty can afford, and just bet for that 10 seconds to extract some 0.1% value, and get your 10 billions in 10 seconds.

Diversification is indeed the defense against ignorance, because no one can simply be sure of everything at every moment. Diversification is a self-acknowledgement of one’s own ignorance to the future events. Of course, this is not a black & white issue either. The more certain you are, the more you should concentrate your assets into the desired allocations. The less certain you are, the more diversified your money should be. In the case of index investing, you’re simply taking the market average without adding anymore of your own opinions.

Time after time, the only true defense against unknowable events is diversification. You should really read The Four Pillars of Investing. There is close to zero mutual funds that beat market index in an extended time-frame. Tens of thousands of smart money managers cannot beat the market on a consistent basis. That should tell you something.