Diversification Or Diworsification?

by: Income Machine
Summary

To diversify or not, that is the question.

Investment proverbs are often accepted as dogma. But when you dig deeper you find some inconsistencies.

Read all that you can from the legends, but digest each morsel with a grain of salt.

Do you ever feel like it’s difficult to extract wisdom from investing proverbs? Or maybe you understand the message, but it directly conflicts with other renowned adages. On one hand you have quotes like:

“Don’t put all your eggs in one basket.”

Source

That quote is not obscure. In fact it is quite simple: diversify. If you put all your eggs in one basket, concentration risk leaves you overly completely exposed if you pick the wrong horse. And even the most lucky and astute investors make bad calls now and again. Even those of us who know what we are doing.

Especially those of us who know what we are doing.

You don’t have to search very far to find one of those self-assured individuals. On that note, let me provide a quote that directly contradicts the previous from none other than the Oracle of Omaha, Mr. Warren Buffett:

“Diversification is protection against ignorance. It makes little sense if you know what you are doing.”

Source

Far be it from me to refute the greatest investor of our lifetimes, but let me poke some holes nonetheless. After all, as you may have guessed, I know what I’m doing. Mr. Buffett is rightfully celebrated and admired for producing long-term returns which consistently outperform the market. But is he really as concentrated as his quote portends?

No. Below is a list of just half of his holding company Berkshire Hathaway’s (BRKA) positions:

CNBC

Not only does Berkshire hold positions across a variety of industries like consumer staples, healthcare, banking, and airlines, he is diversified within the same sector. Here’s the identical list with intra-industry diversification highlighted:

And if that’s not revealing, the second half of the list includes even more names within the same industry. Banking: Wells Fargo (WFC), M&T Bank (MTB), U.S. Bancorp (USB). Airlines: United Continental (UAL), Southwest Airlines (LUV). To steal a line from his quote, maybe he doesn’t know what he is doing.

If Buffett ain’t diversified, then dollar bills ain’t green.

But my point is not to marginalize the voluminous words of wisdom and contributions Buffett provides to us admiring acolytes. His buy-and-hold philosophy is a demonstrable winner and his returns speak for themselves. My point is rather navigating this ‘game’ of finance and public markets and advice is not as simple and devoid of hypocrisy as we may believe. Or to put it a different way, even the best investors reserve the right to change their minds and alter their opinions so be careful when adopting investment proverbs.

In short, there is very little dogma.

After all it was Buffett himself who once expressed his animosity towards airlines like this:

Forbes

And today? I believe Berkshire collectively owns more airline stock than any other hedge fund or capital firm. How times change. Perhaps that initial quote was taken out of context or it was one of those: ‘Do as I say not as I do’ sort of things. Or maybe he just simply changed his mind as consolidation took shape.

It’s actually quite remarkable that Berkshire has trounced so many other investment firms considering how it absolutely whiffed on the exponential appreciation seen in names like Alphabet (GOOG), Facebook (FB), Netflix (NFLX), Microsoft (MSFT), Amazon (AMZN), and to be fair even Apple (OTC:APPL). Berkshire bought into Apple initially at $109, which looks cheap in hindsight, but they were not particularly early. Let’s be frank; they weren’t remotely early. Take a look at when Buffett bought Apple:

YCharts

An appreciation of 100% is nothing to sniff at, but let’s not call it particularly prescient either. Is my implication that Buffett is a poor investor? Emphatically not. I am just indicating that Buffett succeeded despite missing some of the darlings of the market, and that may be inconsistent with his reputation as one who picks big winners. But the market and the proverbs are riddled with inconsistencies.

Buffett is a legend and he deserves much more accolades than derision. His quotes resonate with millions of us not just because of their content but because they are backstopped by results, his limitless passion, and infectious sense of humor.

So do yourself a favor and read all the Buffett and Munger material you can find. You will be a better investor for it. Just don’t accept it all at face value.

And for heavens sake, diversify.

Disclosure: I am/we are long AAPL.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.