Warren Buffett on Diversification

Not a day goes by that I don’t hear a talking head on CNBC talking about a well diversified portfolio. Diversification must be a required course in money management school. Here is a commonly accepted definition from the U.S. Securities and Exchange Commission’s web site,

One of way of diversifying your investments within an asset category is to identify and invest in a wide range of companies and industry sectors. But the stock portion of your investment portfolio won’t be diversified, for example, if you only invest in only four or five individual stocks. You’ll need at least a dozen carefully selected individual stocks to be truly diversified.

I have never been a big fan of diversification. Most people end up di-worse-si-fying their portfolios by adding stocks in unfamiliar sectors for the sake of diversification. It is a little easier with the advent of ETFs. Now, one can simply choose an ETF for additional exposure as opposed to trying to become a good stock picker in many different sectors.

Warren Buffett is one of the greatest investors of our time. It shouldn’t be surprising that he doesn’t follow conventional wisdom. However, I was surprised when I found out that diversification isn’t his cup of tea.

A couple of professors just completed a study of Buffett’s trades over the past 25 years – take a gander here. There are many good take aways from the paper. One that really caught my attention is that over the past 25 years, his top 5 holdings, on average, have comprised 73% of his portfolio. So much for diversification.

Another interesting characteristic is that on average his portfolio is composed of only 33 stocks. If Warren Buffett only has 33 stocks in his multi-billion dollar portfolio - how many should the average investor hold?

My mantra has been concentrate to get rich – diversify to stay rich. I may need to reconsider the last part.

Comments

[Jona:]

Interesting article. It agrees with the following Buffet quote:

Wide diversification is only required when investors do not understand what they are doing.
-- Warren Buffet

2007 Nov 20 10:05 PM

[Geoff Consi...:]

Nice article. Thanks for bringing this valuable research article to the fore!

2007 Dec 07 12:40 AM

[Blue Sword:]

Where is the research study on Warrent Buffet mentioned in your article? Thanks!

2007 Dec 21 04:32 PM

[Capital Pre...:]

In the words of Marty Whitman, "Diversification is a surrogate - usually a poor one - for control, knowledge, and price sensitivity."

2008 Jan 02 08:12 AM