My Favorite Investing Lesson from Warren Buffett

Warren Buffett — at age 91, still the CEO of Berkshire Hathaway — is one of the greatest investors of our time. Shares of the conglomerate have produced a compound annual return of more than 20% between 1965 and 2021, compared to just 10.5% for the S&P 500 over the same period. A large part of that outperformance was driven by its huge equities portfolio, which has also generated outstanding returns over the years.

As a result, investors from all over study Buffett’s investing methods, and try to learn to think like he does. Over the decades, he has shared plenty of advice on how to do that, but one of those lessons is a particular favorite of mine.

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Diversification? Who needs it?

A common investing theme you have probably heard before is the need for diversification in your portfolio. To use an idiom even older than the stock market, don’t put all of your eggs in one basket.

The idea is that if you buy stocks across a range of sectors, you will be hedged against various economic environments and scenarios. For instance, while growth and tech stocks performed extremely well in 2021, they have gotten crushed this year. If you also held oil and natural gas stocks, though, you’d have winners this year to help you offset the hit you are taking in tech. In addition, diversification allows you to better stomach the blow if one company in your portfolio really struggles.

But Buffett has long been a critic of too much diversification. “Diversification is protection against ignorance,” he once said. “It makes little sense if you know what you’re doing.”

He clearly is still following his mantra. After all, nearly 65% of Berkshire’s now roughly $314 billion equities portfolio is invested in just four stocks, and roughly 39% of it is invested in just one: the nation’s largest public company, Apple.

Buffett’s thesis is that if you do enough good research, you can make smart calculated risks and buy stocks at attractive valuations that will reward patient, long-term investors. He also believes that once you’ve done the necessary work, if you see a great opportunity, you should go in big, not small.

Think about what’s in your portfolio today. Do you feel better about the stocks you invested in after doing minimal research or the ones you spent days and weeks investigating?

When it comes to the stocks you did more research on, you probably know every facet of their business, and you likely also considered how they might perform in a negative scenario or a broad-based recession. I’d bet that you’re a lot less concerned about how the stocks you researched thoroughly are currently performing, and are more confident that they will rebound and eventually generate strong returns.

Should you abandon diversification?

Now, I don’t believe Buffett was telling the common investor to totally abandon diversification, and I don’t think you should either if you like the strategy. The reality is that few of us have anywhere close to Buffett’s experience as an investor, nor do most of us spend much of our workdays researching stocks. And Buffett invests hundreds of billions of dollars on behalf of a huge conglomerate, and has opportunities the rest of us lack. He also has many stakeholders he must answer to. You, as a small retail investor, need to manage your portfolio in the way that’s best for you. Diversification is a proven concept that can still produce great returns over a long-term horizon.

But I love Buffett’s take on diversification because I believe the more thoroughly you research your stocks before buying them, the better those you choose will perform. You will also feel a lot more confident about those stocks, which will allow you to sleep a lot better at night, especially during tough market conditions like the ones we’re experiencing this year.

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Bram Berkowitz has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Apple and Berkshire Hathaway (B shares). The Motley Fool recommends the following options: long January 2023 $200 calls on Berkshire Hathaway (B shares), long March 2023 $120 calls on Apple, short January 2023 $200 puts on Berkshire Hathaway (B shares), short January 2023 $265 calls on Berkshire Hathaway (B shares), and short March 2023 $130 calls on Apple. The Motley Fool has a disclosure policy.

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