Advertisement
U.S. markets closed
  • S&P 500

    5,254.35
    +5.86 (+0.11%)
     
  • Dow 30

    39,807.37
    +47.29 (+0.12%)
     
  • Nasdaq

    16,379.46
    -20.06 (-0.12%)
     
  • Russell 2000

    2,124.55
    +10.20 (+0.48%)
     
  • Crude Oil

    83.11
    -0.06 (-0.07%)
     
  • Gold

    2,254.80
    +16.40 (+0.73%)
     
  • Silver

    25.10
    +0.18 (+0.74%)
     
  • EUR/USD

    1.0779
    -0.0014 (-0.13%)
     
  • 10-Yr Bond

    4.2060
    +0.0100 (+0.24%)
     
  • GBP/USD

    1.2624
    +0.0002 (+0.02%)
     
  • USD/JPY

    151.2870
    -0.0850 (-0.06%)
     
  • Bitcoin USD

    70,479.77
    +933.42 (+1.34%)
     
  • CMC Crypto 200

    885.54
    0.00 (0.00%)
     
  • FTSE 100

    7,952.62
    +20.64 (+0.26%)
     
  • Nikkei 225

    40,345.64
    +177.57 (+0.44%)
     

Warren Buffett: 3 to 6 Stocks Is Enough

- By

In a recent article, I highlighted a number of quotes from the Warren Buffett (Trades, Portfolio) which are easy to misinterpret when taken in isolation. One of the topics I looked at in particular was Buffett's quotes on diversification. Over the years, Buffett has frequently warned investors that diversification can be damaging to returns. Below is a collection of Buffett quotes on this subject:



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

"A lot of great fortunes in the world have been made by owning asinglewonderful business. If you understand the business, you don't need to own very many of them."

"Wide diversification is only required when investors do not understand what they are doing."

"A lot of great fortunes in the world have been made by owning a single wonderful business. If you understand the business, you don't need to own very many of them."

"Diversification may preserve wealth, but concentration builds wealth."


The reality is that each investor is different, so there's no one right answer to the topic of how much diversification one should have in a portfolio and whether or not one is diversified enough. It really comes down to personal preference - and, as Buffett says, whether or not you truly understand the businesses you are investing in.

The puzzle of diversification

It is true that many successful investors and business people can trace the roots of their success back to a highly profitable company or a single investment. However, this analysis is steeped in survivorship bias. Everyone knows the name of Mark Zuckerberg and the company that made him rich, Facebook (NASDAQ:FB). Still, for every person who got rich investing in Facebook, there are probably 1,000 individuals who invested everything in some other flashy internet stock and lost it all.

Even Buffett has never come close to risking all of his capital in one investment. His most significant investment, in terms of total assets, was GEICO stock in the 1950s. He invested around half of his net worth at the time in the company. This trade worked out, but he still would have been left with 50% of his capital if it hadn't. Buffett's most significant investments have never really exceeded 50% of his net worth throughout his career.

At the time of writing, Berkshire Hathaway's (NYSE:BRK.A) (NYSE:BRK.A) investment in Apple (NASDAQ:AAPL) accounts for around 41% of its equity portfolio, but we should view this investment in the broader context of the conglomerate. With more than $700 billion worth of assets, the Apple holding makes up approximately 17% of assets overall.

Buffett has never said investors should avoid diversification entirely. It seems as if he has always believed investors should have some diversification, but not too much, and not if it comes at the cost of investing in things they don't understand. Indeed, Buffett has said in the past that all one needs is "three wonderful businesses" to get rich, although he has also noted that "six wonderful businesses" could be "all the diversification you need."


"Very few people have gotten rich on their seventh best idea. But a lot of people have gotten rich with their best idea. So I would say for anyone working with normal capital who really knows the businesses they have gone into, six is plenty."


This is something investors should keep in mind when looking for different assets to add to a portfolio. Excessive diversification can be detrimental to returns, but some diversification into companies that one understands well will not likely end in disaster. In fact, having just a bit of diversification can protect against disaster.

This is all said with the warning that diversification does not make up for a lack of research. The easiest way to reduce risk in a portfolio is through research. Buffett's advice on diversification is worthless if it is not coupled with rigorous investment research.

This article first appeared on GuruFocus.

Advertisement