Diversified Portfolio

Why Warren Buffett Prefers Concentration

Stocks can be thought of like a bell curve: some will do poorly, some very well, but most will be average. Warren Buffett’s strategy is to find and focus on the few stocks that will do the best. He believes that by concentrating on these top performers, he can get the highest returns. Since only a few stocks are likely to be top performers, he chooses to concentrate his investments rather than spread them out.

Warren Buffett manages a huge amount of money, which gives him access to resources that regular investors might not have. One big advantage he has is time. Buffett spends all his time studying and analyzing businesses. Over the decades, he has gained a lot of experience and skill in investing, which helps him successfully focus on a few investments. On the other hand, most regular investors have day jobs and can’t spend as much time on investing as Buffett does. So, while they can still learn from his strategies, they might need to find a good balance that works for their own situations.

Retail Investors Don't Have Warren Buffett's Resources or Time

The Risks of Concentration

Following the bell curve idea, as lifelong learners of investing, there’s a risk that instead of picking winners, we might choose losers, which could be disastrous. As retail investors, we are still learning and gaining experience over time. Huge losses might discourage us and make us quit investing too soon. Also, even if we choose correctly, a concentrated portfolio can be very volatile, and many retail investors might find it hard to deal with the ups and downs.

For retail investors, the goal is to remain invested over the long term—throughout the decades leading up to retirement—to harness the power of compounding and grow our wealth.

Diversification is a Smart and Practical Choice for Retail Investors

Diversification in the Philippine Context

We recommend that investors avoid trying to focus too narrowly on picking the very best, or those that fall two standard deviations from the mean. Instead, aim to capture companies on the right side of the bell curve, representing above-average performers, which is a more achievable goal for retail investors. We believe it’s best for investors to build their portfolios gradually. Instead of investing all your money at once, consider buying slowly over time. Aim to eventually hold 10-25 stocks in your portfolio, focusing on stocks that consistently pay dividends. This approach provides a balanced portfolio size, which is a practical and rewarding target for many retail investors.

If you want less to manage, aim for about 10 stocks. If you’re comfortable with more, consider expanding to up to 25 stocks for better diversification. We don’t recommend exceeding 25 stocks for retail investors, as the Philippine market is relatively small and it may be challenging to find that many outstanding companies. Additionally, managing a large number of stocks can become impractical.

Aim to Build a Well-Balanced Portfolio of 10-25 Stocks

Practical Benefits of Diversification

Protection Against Investing Mistakes

Even the great Warren Buffett occasionally makes mistakes. In our investing journey, mistakes are inevitable, and it’s unrealistic to think we will always make the right choices. While we hope for successful investments, we should be practical investors. Business landscapes are unpredictable, and even strong companies can face sudden challenges. Diversification provides protection against these uncertainties. If some of our investments encounter issues, the rest of the portfolio can help offset the losses, allowing us to achieve satisfactory returns overall.

Smoother Ride with Less Volatility

Many people underestimate the importance of experience and psychology in investing, focusing only on total returns. However, a highly volatile investing experience can discourage many investors. Our goal is for individuals to remain invested for the long haul and reap the benefits of compounding. Diversification helps create a less volatile portfolio, making it easier for investors to stick with their investments over time and weather the ups and downs with greater resilience.

Balanced Exposure and Adapting to Market Changes

Balanced exposure means investing in different industries that grow at different times. This approach allows your portfolio to benefit from a variety of market opportunities. By spreading investments across multiple sectors, you can reduce the risk that comes from relying on just one area and increase your chances of steady growth over time.

Building Investment Confidence

Building investment confidence means feeling sure about your investment choices. Diversifying your portfolio helps by spreading risk across different investments, so you’re less worried about big losses. A stable portfolio can help you stay calm during tough market times and stick to your long-term goals. This way, you learn that a mix of investments can handle ups and downs and still grow over time.

Keeping Your Portfolio Balanced

Over time, some investments in your portfolio might grow more than others, changing the mix you started with. Keeping your portfolio balanced means adjusting your investments to stay on track with your original plan. This might mean selling a bit of what went up and buying more of what hasn’t grown as much. By doing this regularly, you make sure your investments stay in line with your goals.

Exploring and Experimenting with New Opportunities

As we learn, we may want to experiment with something new, like small caps or stocks from industries we’ve never tried before, that also pay good dividends. Having a stable portfolio allows us to explore these opportunities, welcoming new insights and potential growth without compromising our overall investment strategy.

Focusing on the Long Term

Diversification allows investors to concentrate on long-term goals without getting sidetracked by short-term market fluctuations. By spreading investments across various types of stocks, such as different industries or market caps, you create a portfolio that can better withstand market volatility. This enables you to stay focused on your future objectives. This practical approach ensures that your investments align with a long-term strategy, taking advantage of compounding growth. It offers a manageable and sustainable path toward retirement, making it more accessible compared to more complex strategies.