May 8, 2024
Aside from his savvy investment decisions, Warren Buffett is known for making some of the most colorful analogies in the finance industry.
For example, he once used NBA star LeBron James as an analogy for why professional investors shouldn’t focus too much on diversification.
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"If it's your game, diversification doesn't make sense,” he said. “If you have Lebron James on your team, don't take him out of the game just to make room for someone else… It's crazy to put money into your 20th choice rather than your first choice.”
Here’s why the Oracle of Omaha resists diversity for the sake of diversifying — although it might not be the best strategy for the average investor.
Buffett’s concentrated bets
Buffett’s portfolio held in Berkshire Hathaway’s account is notoriously concentrated in only a handful of stocks. By the end of 2023, the multinational conglomerate holding company had 41 stocks altogether, but many of these were less than 1% of the portfolio.
A jaw-dropping 50.19% of the portfolio was dedicated to just one stock: Apple. The top three stocks — Apple, American Express and Bank of America — account for 68% of the total value of the portfolio.
In a meeting with his shareholders, Buffett said this approach was valid because he was acting on professional experience and a deep conviction. “If you know how to analyze [and] value businesses, it’s crazy to own 50 stocks,” he said. “Three wonderful businesses is more than you need in this life to do very well.”
In other words, the Oracle of Omaha is confident in his ability to pick the best eggs, put them all in one basket and watch that basket closely.
However, it should be noted that Buffett isn’t as concentrated as it appears on his annual filings. That’s because he owns a wide range of other businesses, privately, inside the Berkshire Hathaway corporation.
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The portfolio of private companies in this umbrella range from energy giants and insurance providers to candy factories and furniture makers.
Altogether, Buffett is actually quite well-diversified, and he recommends diversification for the ordinary investor, too.
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The benefits of diversification
Professional investors like Buffett, Jim Simons, David Einhorn and Daniel Loeb, have dedicated their lives to the stock game. They also have immense resources in the form of multinational corporations and an army of young talented analysts working to assist them.
In this environment, it’s easier to move forward with conviction on a handful of stocks and closely monitor every single earnings report.
However, the average investor likely has other employment that leaves little time (or energy) for such in-depth stock analysis. A dentist, plumber or high-school teacher, for example, won’t necessarily have the capacity to attend shareholder meetings and analyze earnings reports every week.
For these individuals, Buffett believes the best approach is a well-diversified passive index fund. Vanguard S&P 500 ETFs, for instance, track the performance of the underlying index and has delivered an attractive 14% compounded annual growth rate since its inception in 2010. That’s a decent return with minimal effort.
“Diversification is a protection against ignorance,” Buffett said. “I mean, if you want to make sure that nothing bad happens to you relative to the market… There's nothing wrong with that. That’s a perfectly sound approach for somebody who does not feel they know how to analyze businesses.”
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Vishesh Raisinghani is a financial journalist covering personal finance, investing and the global economy. He's also the founder of Sharpe Ascension Inc., a content marketing agency focused on investment firms. His work has appeared in Moneywise, Yahoo Finance!, Motley Fool, Seeking Alpha, Mergers & Acquisitions Magazine and Piggybank.
