Warren Buffett and Diversification

Diversification too — like all Value Investing — is counter intuitive. More diversification is normally assumed to be better, but it's not.

1984 Talk

Warren Buffett gave a talk in 1984 at Columbia Business School, known today as The Superinvestors of Graham-and-Doddsville.

In the talk, Buffett says:

"In this group of successful investors that I want to consider, there has been a common intellectual patriarch, Ben Graham."

"Walter [Schloss] has diversified enormously, owning well over 100 stocks currently."

"[Charlie Munger] set up a partnership quite the opposite of Walter’s. His portfolio was concentrated in very few securities and therefore his record was much more volatile but it was based on the same discount-from-value approach."

1993 Letter

In his 1993 annual letter to shareholders, Warren Buffett writes:

"Portfolio concentration may well decrease risk if it raises, as it should, both the intensity with which an investor thinks about a business and the comfort-level he must feel with its economic characteristics before buying into it."

"If you are a know-something investor, able to understand business economics and to find five to ten sensibly-priced companies that possess important long-term competitive advantages, conventional diversification makes no sense for you. It is apt simply to hurt your results and increase your risk."

Warren Buffett, Berkshire Hathaway: Letter to Shareholders (1993).

But Buffett also writes in the same letter:

"Of course, some investment strategies - for instance, our efforts in arbitrage over the years - require wide diversification. If significant risk exists in a single transaction, overall risk should be reduced by making that purchase one of many mutually-independent commitments."

"Another situation requiring wide diversification occurs when an investor who does not understand the economics of specific businesses nevertheless believes it in his interest to be a long-term owner of American industry."

Warren Buffett, Berkshire Hathaway: Letter to Shareholders (1993).

The Intelligent Investor

Buffett also wrote the preface to Benjamin Graham's book — The Intelligent Investor — and called it "by far the best book about investing ever written."

"There should be adequate though not excessive diversification."
Benjamin Graham, Chapter 5: The Defensive Investor and Common Stocks, The Intelligent Investor
Advanced Graham Screener

Customized Value Investing

To Summarize

The passages above explain the principle of diversification perfectly. Concentration yields better results, but is best employed by those with exceptional skill and experience. Diversification protects the average investor from losses.

So there's really no "one size fits all" rule when it comes to diversification.

The idea is that it's not only more profitable — but also safer — to put your money in a few well researched holdings rather a lot of poorly researched ones. So the deciding factor here is if one has the time and opportunity to do the research well.

Related: Buffett's comments on the importance of focus and Graham's instructions on position sizing.

Buffett Explains

Buffett gave the following detailed explanation of his views on diversification at the 1996 Berkshire Hathaway Annual Shareholders Meeting.

Graham Resources