If Buffett, Dalio, and Icahn do it, why don't you?
Yes these are some of my kids....and my chickens
No client of Beck Bode owns more than 25 stocks, and believe me, we get plenty of raised eyebrows for that.
“Isn’t that risky? Is that safe? What about diversification? Aren't you putting all your eggs in one basket?”
And yes these are their eggs.
Fair questions, but the better question is, “how does that compare to the way the most successful investors in the world manage money?”
I believe in studying the best of the best in whatever your chosen discipline, and if your goal is to accumulate wealth, it makes sense to study the super rich and figure out how they made their money.
And guess what, the super rich don’t build wealth by investing in a mix of mutual funds and ETF’s. They select a concentrated number of investments.
Being overly diversified in funds is a guaranteed way to find yourself somewhere in the middle of the pack.
Warren Buffett says, “Diversification is a protection against ignorance. It makes very little sense for those who know what they are doing.”
Charlie Munger, Buffett’s partner, says “Students learn corporate finance at business schools. They are taught that the whole secret is diversification. But the exact rule is the opposite. The ‘know-nothing’ investor should practice diversification, but it is crazy if you are an expert. The goal of investment is to find situations where it is safe not to diversify. If you only put 20% into the opportunity of a life-time, you are not being rational. Very seldom do we get to buy as much of any good idea as we would like to.”
Multi billionaire hedge fund manager Stanley Druckenmiller says, “Diversification is the most destructive, over-rated concept in our business. Look at George Soros, Carl Icahn, Warren Buffett. What do they have in common? They make huge concentrated investments. You need ruthless discipline.”
Billionaire hedge fund manager Seth Klarman says, “The number of securities that should be owned to reduce portfolio risk is not great; as few as ten to fifteen holdings usually suffice.”
And research supports their position.
According to a study done by Yueng et al (2012) titled “Diversification versus Concentration…and the Winner is?” the lower the number of holdings, the higher the returns, and more importantly, when investing in more than 30 companies, the decrease in standard deviation, aka the decrease in risk, is negligible.
In other words, your risk doesn’t decrease significantly by owning more than 30 companies, but your performance does.
In "Modern Portfolio Theory and Investment Analysis,” by Edwin J. Elton and Martin J. Gruber, they conclude that the average standard deviation (risk) of a one stock portfolio is 49.2%, and increasing stocks in that portfolio could decrease risk to a standard deviation as low as 19.2% (which represents market risk).
They also note that with a portfolio of 20 stocks, the risk is reduced to about 20 percent.
Therefore, the first 20 stocks reduce the portfolio's risk by 29.2 percent (49.2% - 29.2% = 20%), and since the least risky portfolio will have a standard deviation of 19.2%, additional stocks from 21 to 1,000 only reduce the portfolio's risk by about 0.8 percent.
In other words, the difference in risk between owning 20 stocks and 1,000 stocks is negligible.
In Principles, hedge fund manager Ray Dalio says he aims for 15 uncorrelated bets.
In the Intelligent Investor by Benjamin Graham (Buffett’s mentor), he recommends holding between 10-30 companies.
So I ask, is concentrated investing really more risky?
Or is concentrated investing when you don’t know what you’re doing more risky?
I get it. Stock market volatility is all over the news. The thought of losing money is scary.
And make no mistake, a bad investor in funds will beat a mediocre investor in a concentrated portfolio, but I challenge you to find someone who knows what they are doing. It could mean the difference of millions of dollars.
Follow in the footsteps of the greats. Just because the majority of people use funds doesn’t mean it is the right thing to do.
Don’t take my word for it. Take advice from titans like Buffett, Dalio, and Icahn.
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