Why Buffett Avoids Diversification

We try to avoid buying a little of this or that when we are only lukewarm about the business or its price. When we are convinced as to attractiveness, we believe in buying worthwhile amounts.” — Warren Buffett, 1978 Berkshire Hathaway letter to shareholders

Just about any article, book or lecture discussing an introduction to investing will say that it’s important to diversify in order to be successful. Based on conventional wisdom, by owning a large number of stocks in multiple sectors, you will reduce your risk and take a minimal hit if a single sector or company has problems.

Investing guru and CEO of Berkshire Hathaway, Warren Buffett, will tell investors that they should take this particular wisdom with a grain of salt. Throughout his career, Warren Buffett has avoided diversification consistently when investing for Berkshire Hathaway. On the contrary, he has made big purchases of a few companies like American Express and Coca-Cola.

Stick to Your Greatest Ideas

Buffett’s particular insight in this instance is that it’s tough for a single person – even Buffett himself – to have a tremendous amount of insight about dozens of companies all across the stock market. Buffett understands a few areas very well and he’s comfortable making investments in them, including: consumer goods, media, banking and insurance, which are just a few of his favorites.

Buffett understands these sectors very well, so when he realizes that a specific stock is undervalued at the time, he’s very confident to make a big investment in that business. For the most part, when he gets it right, he is even willing to let his money ride instead of selling shares in order to make a quick profit.

Buffett is willing to take on great risk by having a concentrated Berkshire Hathaway portfolio. However, this makes a great deal of sense when you consider his alternative: buying stock in companies that he does not understand or that he does not like and making them is top holdings.

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