Warren Buffett On Diversification

Reader “sumflows” uploaded this video from Warren Buffett’s speech at Florida that discussed Buffett’s advice on diversification, and the best part about it is that Buffett gives advice based on the particular goals that leads each person to investing in the first place.


If you are someone that is making $9,000 per month post-tax and is only spending $6,500 of it, and you don’t have a particular desire to spend a lot of time studying individual companies, then it makes a lot of sense to open up an account with Vanguard and funnel the money into the S&P 500 Index Fund each month that barely costs anything in fees (the expense ratio for “VFINX” is 0.17%, meaning you would have to pay $17 each year on every $10,000 you entrust to this S&P 500 Index Fund run by Vanguard).

The first of the two main advantages with this strategy is that if you only have a moderate interest in investing, you don’t have to spend a whole lot of time worrying about investments. Your focus is making money, spending less than you earn, and then doing the things you enjoy. For the person that doesn’t take on investing as a serious hobby/lifestyle choice, index funds are great options.

The other advantage of index investing is that you don’t have to deal with company specific risk. When long-time General Electric shareholders saw a $40 share price quickly turn to the $6-$12 range, they had to make a discerning decision to determine why it would make sense to buy or hold GE stock compared to, say, Wachovia which had similar risk profile elements but did not survive.

With an S&P 500 fund, you can feel comfortable socking more money after a 30% decline because you are only betting on a general economic recovery: that Exxon will sell more gas 10 years from now, Microsoft will sell more Software, Apple will sell more phone, Pfizer will sell more prescription drugs, Johnson & Johnson will sell more Tylenol, McDonalds will sell more cheeseburgers, and so on. It’s a more general bet on the future of American and global commerce, and that can make committing more money after a steep drop easier.

For investors that take things seriously, I get where Buffett is coming from when he says that someone should only own six stocks. If I had to guess which companies would still be paying out dividends a century from now, I’d bet on Johnson & Johnson, Colgate-Palmolive, Nestle, Exxon, Coca-Cola, and Disney. It’s very reasonable to think that any portfolio I construct over my lifetime will deliver inferior results than a portfolio that consists solely of those six companies.

Knowing this, why wouldn’t I want to proceed differently? Because if I’m wrong in a big way, I could lose 17% or 33% of my capital fairly quickly. I’d feel a lot better throwing General Mills, Procter & Gamble, Pepsi, Chevron, Kraft, and some others into the mix to hedge myself against unforeseen events. I’d rather build a collection of the best businesses I can find than try to eke out that extra 1-3% of portfolio return (by the way, that 1% or 2% adds up over a long period of time, but then again, who knows? P&G could outperform Disney over the next 50 years, so hedging could end up having an “improving” effect overall).

I think there are fifty or so truly excellent businesses in the world, and I’d rather spend my time gradually accumulating each of them rather than splitting hairs about trying to figure out whether Exxon or Chevron is better. I think “both please” is the right answer.


Originally posted 2014-01-01 20:30:09.

Like this general content? Join The Conservative Income Investor on Patreon for discussion of specific stocks!

2 thoughts on “Warren Buffett On Diversification

  1. scchan_2009 says:

    I think I once see figures that once you own about 10-40 positions, you are diversified enough that you will close to replicate the general market trend. The problem with owning many different stocks or investing in an index fund is the same – cost. Former comes from trading cost and latter comes from expenses. Warren himself said that index funds are good as long as you check the expense ratio. I think any expense ratio over 0.3% is a rip off; a thing about US-based index funds and ETFs are there enough choices that drive the expenses down. If you want to get an index funds that track major indices in Europe or Asia, expenses will be somewhat higher.In the end, no one really knows what the future is. The iron rule is that past performance is not indicative to the future, yet people really like past performance. This is why you should always remember Lynch's rule that one must not invest in companies with complicated business models – you can't go too wrong with Tides (P&G) or Mickey Mouse and TV live Red Sox vs Yankees (DIsney). Did people really understand what Enron do before they go bust? If you are going to pick individual stocks over index funds – stick with easy to understand businesses (it doesn't have to be Disney or P&G or Coke, but you get that point).

  2. Troy Osborne says:

    Just one more copywrite of the same info. If you want to get really professional unique information on this matter – turn to compacom.com website. Their authors offer only expert opinion and advice. Any time I’m in doubt in some financial matters, I read compacom.com articles.

Leave a Reply