Eggs, Baskets and Risk

 | Dec 14, 2011 | 8:40 AM EST
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This piece originally appeared on Real Money Pro.

The CNBC Million Dollar Portfolio challenge is now a week under way, so some traders can get their focus back on using actual dollars and away from Monopoly money. I find the whole challenge a bit laughable, because a prudent diversified approach to investing wouldn't work well, nor would tight stops or scaling trades lead you to victory. No, this is a contest where you have to put all your eggs in one basket. Even more, it is a long equity basket without options and above a stated market cap. In the end, it is 50% luck, 50% timing, and 10% skill. There is probably another 25% in there for luck as well. (The numbers make about as much sense as the challenge.)

However, it got me thinking about the idea of putting all your eggs in one basket. On the surface, it is a risky proposition that risks more than it rewards. You should never do it ... right? After all, it breaks a cardinal rule: Slow and steady wins the race. With a nice diversified portfolio, you'll be able to enjoy the fruits of your steadfast, careful approach in your golden years. But when I look around at most of the very successful folks that I know, they didn't take that path. The person who quit her job to risk everything and start her own business, the professional athlete who left school early and focused only on his sport, the trader/manager who took one very large position in a specific thesis, sector or even company -- these are some of the folks who find such great success so quickly that work becomes optional going forward. Perhaps they can focus on doing what they truly love, if they are not doing it already. But there is a difference to consider here, and it comes down to the eggs.

The immediate thought is, whose eggs are you putting in the basket? If you are a hedge fund manager, they may be someone else's eggs. But in most cases, the risk being taken is with one's own money, time and energy. Setting aside the possibility of taking the risk with someone else's eggs, then, there is one other thing I found that mattered: I believe someone is much more likely to put all his eggs in one basket if he believes there will be more eggs to come in the future -- another opportunity down the line, in other words.

If you are a professional athlete, perhaps you have a guaranteed contract, endorsement deal or the potential of a new contract forthcoming. If you are a trader, perhaps you work another job as well that feeds your trading account. You know that even if you lose $20,000 on this one trade or one position, you'll be able to replace it within a year, but you wouldn't be able to replace a five- or 10-fold upside anytime soon, so you take a chance. A business owner or entrepreneur may understand failure is often a part of eventually succeeding, and they are bound to fail if they don't put everything they have into their idea. By not putting all their eggs in one basket, they may actually guarantee failure, so rather than spreading risk, they may actually increase it.

In the end, everyone has to make decisions for himself. A risk-averse or diversified approach is often the best approach for most, but for some -- a small few -- consider pushing aside the cliches and making a decision based on knowing yourself and your own situation. I think 2012 will bring one or two of these baskets, but they are not for everyone. The weight and stress don't permit much sleep at night, and some baskets will fall apart. Just know if you can mend the basket and refill it with eggs before you try lifting the first one.

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