What's Wrong With Diversification?
At first glance, that question might make it appear as if I am about to trample on one of the investing world's most cherished "sacred cows" - you know the routine - "do your asset allocation, rebalance your portfolio periodically, and D-I-V-E-R-S-I-F-Y."
I have repeated those very words at our monthly meetings many times, however, a few words of caution need to be stated in the case of diversification.
Owning any portfolio that is overly diversified makes it very difficult to earn really good profits because while some of your stocks rally, others will tank. So what you end up with is a portfolio that merely mimics the broad market. Investing like that may seem to be a safer way to do it but in reality, by attempting to minimize your losses, you're also limiting your gains.
The best way to make big money buying stocks is to focus your capital on cheap stocks that you understand very well. Which do you think you could be more successful doing: could you know everything you needed to know on a short list of 10 to 15 stocks? Or, how about a long list with hundreds of stocks - the way that many mutual fund managers do?
Warren Buffett has a very definite opinion on the subject of diversification. He has been quoted as saying, "Diversification is only done by people who really don't know what they're doing."
Once again, I have to agree with Warren Buffett. Just think about it... why does any person diversify?... A person diversifies because of the fear of losing. And what is the source of that fear?... All fears stem from ignorance of whatever it is that we fear!
Back in 1963, Warren Buffett had $12 million under management. He invested all of that money in just five stocks. Now he could have chosen to diversify that money over dozens and dozens of seemingly quality stocks but instead of doing that, he chose instead to work very, very hard and as a result, he came up with just a few very sound investments like American Express and Berkshire Hathaway.
The wisdom of Buffett's approach to investing were revealed by the end of 1963, when his portfolio had gained 39% while the Dow had gained only 21% that same year. And by the end of 1964 - one year later - Buffett's portfolio had grown to $22 million from the original $12 million.
In order to make large gains like that Buffett's goal is to just pick winners and to invest exclusively in them. He doesn't waste time or money on stocks he doesn't know and understand completely. To do otherwise he feels would be very much like playing the lottery.
Buffett's strategy works because his Berkshire Hathaway shares have gained nearly 195,000% since 1964!
So if you want to develop a winning portfolio, then don't clutter it up by over diversifying with potential losers that will only limit any gains that you make on your best stock picks.
* * * * *
I have repeated those very words at our monthly meetings many times, however, a few words of caution need to be stated in the case of diversification.
Owning any portfolio that is overly diversified makes it very difficult to earn really good profits because while some of your stocks rally, others will tank. So what you end up with is a portfolio that merely mimics the broad market. Investing like that may seem to be a safer way to do it but in reality, by attempting to minimize your losses, you're also limiting your gains.
The best way to make big money buying stocks is to focus your capital on cheap stocks that you understand very well. Which do you think you could be more successful doing: could you know everything you needed to know on a short list of 10 to 15 stocks? Or, how about a long list with hundreds of stocks - the way that many mutual fund managers do?
Warren Buffett has a very definite opinion on the subject of diversification. He has been quoted as saying, "Diversification is only done by people who really don't know what they're doing."
Once again, I have to agree with Warren Buffett. Just think about it... why does any person diversify?... A person diversifies because of the fear of losing. And what is the source of that fear?... All fears stem from ignorance of whatever it is that we fear!
Back in 1963, Warren Buffett had $12 million under management. He invested all of that money in just five stocks. Now he could have chosen to diversify that money over dozens and dozens of seemingly quality stocks but instead of doing that, he chose instead to work very, very hard and as a result, he came up with just a few very sound investments like American Express and Berkshire Hathaway.
The wisdom of Buffett's approach to investing were revealed by the end of 1963, when his portfolio had gained 39% while the Dow had gained only 21% that same year. And by the end of 1964 - one year later - Buffett's portfolio had grown to $22 million from the original $12 million.
In order to make large gains like that Buffett's goal is to just pick winners and to invest exclusively in them. He doesn't waste time or money on stocks he doesn't know and understand completely. To do otherwise he feels would be very much like playing the lottery.
Buffett's strategy works because his Berkshire Hathaway shares have gained nearly 195,000% since 1964!
So if you want to develop a winning portfolio, then don't clutter it up by over diversifying with potential losers that will only limit any gains that you make on your best stock picks.
* * * * *
posted by Bob Moser at
6:25 PM
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