Diversification: Old School Buffett Style


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Do you diversify? Diversification must be one of money managements most important concept. When you speak to just a regular financial advisor they will probably mention that you haven’t diversified enough. Have you diversified lately?

Two Different Applications

The way Buffett sees it, diversification falls into two categories.
1. Diversification for the conservative, lazy investor
2. Diversification for the intelligent or enterprising investor

The Conservative/Lazy Investor

By definition, a conservative or lazy investor is a person who does not spend too much time studying or being involved with their investments. These people are happy to buy a fund or a stock and check up on it once or twice a year. Wall Street claim these people have ‘boring’ and ‘dull’ strategies. People in this group also prefer not to have realised or unrealised loss.

For this group, Buffett informs us that conservative investors should diversify extensively and keep trading to a minimum. Diversifying extensively simply means buying more stocks or mutual funds. Basically this is what a mutual fund or index fund does. This is a way of owning a tiny piece of America.

The Enterprising Investor

Proud to call yourself an enterprising investor? This is a term created by Benjamin Graham in The Intelligent Investor and refers to people that are keen, eager and willing to devote time in finding investment opportunities and analysing those opportunities.

Enterprising investors are confident in their research, analytical abilities and decision. For enterprisers, Buffett tells us that you should not diversify. Owning around 6 companies is all you need.

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

Back to Sprint Training

Let me explain it in terms of baseball again. You step to the plate and the pitcher throws a dead straight fat yet slow fastball right through the middle.

Do you
a) let it go
b) bunt it and try to get to 1st base
c) flex your muscles, lick you lips, swing hard and try to hit it to the sun

People who chose a and b, don’t hesitate and just buy index funds. C choosers, you know pitches like this don’t come very often. If it does come, are you going to diversify by putting a small portion of the your capital into it and then go searching for 30 identical pitches just to reduce the chance of getting out?

The Key to Diversifying..

is to not diversify. If you are confident in your analysis, you tend not worry about price fluctuations. If it goes down, it is just a greater opportunity to buy more of a great business at a great price. Diversifying is for the conventional safety seekers and followers of Wall Street. Wall Street claims holding less stocks is risky, but the results of Buffett and the Super-Investors prove otherwise. At most times, more than 70% of Buffett’s capital was invested into 4-5 companies. He knew he could hit that fastball and did it. Are you scared to swing at your fastball?

“Diversification is a protection against ignorance. It makes very little sense for those who know what they’re doing.”

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