If you ask 100 financial planners the most important concept in investing, my guess is 99 of them will say diversification. I agree with that sentiment for most people, but not for everyone.
Most people, after all, don’t lead the world. Most are happy to be led, to let someone else take the risks. Most seek first and foremost to stay out of trouble. It works, but it’s not a great way to get ahead.
Diversification is protection against ignorance. If you don’t know what you are doing, diversification allows you to benefit from some of the upside while primarily focusing on protection from the downside.
If you don’t want to take risks, if you don’t know what you are doing, if you don’t want to stand out, or if you are unsure of yourself, then heavy diversification makes a lot of sense.
If, however, you do want to get ahead, diversification is the wrong way to go.
The facts bear out this contention. Investors with the best records don’t diversify heavily, they stay focused in the areas they truly understand and they concentrate their bets there.
In fact, the firms with the best records tend to hold only 5-10 positions per analyst. As any financial planner will tell you, that’s not diversification.
It makes sense, too, if you think about it. If an investor works 250 days a year and 10 hour days, he has 2,500 hours a year to work. If he owns 500 stocks, that’s a mere 5 hours a year to understand each stock. If he owns 100 stocks, that’s 25 hour per stock per year.
How well can an analyst really know a company he studies for 5 to 25 hours a year in a dynamic, rapidly changing economy? Not very well.
Now, suppose his competition only follows 25 or 10 stocks. That’s 100 or 250 hours a year to follow each business. Who do you think knows each business better, understands its competition and economics, evaluates management more thoroughly? The guy who spends 5 to 25 hours per year, or the guy who spends 100 to 250 hours per year?
It’s really no contest.
And that’s why I’m a concentrated investor and consider it a virtue. I’m seeking to lead, to get better than average results, to get ahead.
I know I can’t compete with investors who spend 20 to 50 times more hours understanding each business, and I take great comfort knowing most of my competitors are less focused than I am.
Don’t get me wrong–concentrated investing is not for everyone. It’s almost guaranteed to be more volatile, look more risky, and suffer the criticisms of financial planners.
Those who don’t want to stand out, take intelligent risks, or be criticized won’t enjoy being concentrated. But, for those who do, the rewards are great.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.