Concentrate or diversify?
I think the answer to this one is that it depends on you and what you are buying. If you are sure that you know what you are doing, then you might wish to buy only a few well researched investments. However, even if you know what you are doing and you understand the investment, you should spread your risks if the investment is inherently high risk, e.g. venture capital type investments.
Some investors use "forced displacement". This involves limiting the number of shares owned to a small number. If a new share is to be added, they do so by selling a share presently held. Laura Sloate, Scott Johnston and Foster Friess all limited the number of their holdings through forced displacement.
I give below some quotes regarding this topic from very successful investors:
Burton Malkiel
Your best chance of making yourself fabulously wealthy investing is to buy a few small stocks with good growth possibilities; you just might find the next Microsoft. Of course, it is far more likely that you will lose most of your money this way. On the other hand, although you cannot achieve extremely high returns with a diversified portfolio, it is the best way to avoid a retirement diet of cat food.
John C Bogle
Experience confirms that buying the right stocks, betting on the right investment style, and picking the right money manager - in each case, in advance - is like looking for a needle in a haystack.
Laura Sloate
Focus is the key to success. Why do Warren Buffet and Peter Lynch do well? Because they have their niches and they stick to them. They may evolve them over time.
Gerald Loeb
Diversification is a necessity for the beginner. On the other hand, the really great fortunes were made by concentration.
Confining yourself to situations convincing enough to be entered on a relatively large scale is a great help for safety and profit. Concentration of investments in a minimum of stocks insures that enough time will be given to the choice of each so that every important detail about them will be known.
Once you attain competency, diversification is undesirable.
Only the best is bought at the best possible time. Risks are reduced in two ways – first by the care used in selection, and second, by the maintenance of a large cash reserve.
Peter Lynch
There don’t have to be more than 5 companies in the portfolio at any one time.
Follow five or six companies and know these companies very well. But if none of them is attractive, don’t own any of them.
The best stock to buy may be the one you already own.
Lynch: “It only takes a couple of big winners in a decade to make the effort worthwhile. The smallest investor can follow the Rule of Five and limit the portfolio to five issues. If just one of those is a 10-bagger and the other four go nowhere, you’ve still tripled your money.” (Lynch held many stocks in Magellan because of Magellan’s size.)
Charlie Munger
Winners bet big when they have the odds – otherwise they stay out.
John Neff
I want to create impact by taking outsized positions where I saw promising returns.
James O’Shaughnessy
Researchers J L Evans and S H Archer found most of the benefits of diversification come from as few as 16 stocks. Subsequent research confirms their findings. You also want to avoid holding too many stocks. This can lead to diworsification.
Richard Driehaus
We concentrate our portfolios.
Roger Murray
Do intensive analytical work on a limited number of companies. I would rather have, and I will get better results, from a dozen companies that I really understand.
Scott Johnston
I think you own it and you love it, or you don't buy it. In order to buy a new name, you've got to kick out an old name. That imposes a discipline to always focus on the strongest names in your portfolio. What you're doing all the time is focusing on the very best companies, the very best names.
Jim Slater
Private investors know that, even with a portfolio of ten shares, their first choice is better than their tenth. This is an edge over the institutions that have to invest in several shares simply because of the size of the funds managed by them. Also, limiting the number of shares gives adequate time to monitor the investments in depth.
Warren Buffet
Some investment strategies ... require wide diversification. Most venture capitalists employ this strategy. Should you choose to pursue this course, you should adopt the outlook of the casino that owns a roulette wheel, which will want to see lots of action because it is favored by probabilities, but will refuse to accept a single huge bet.
Another situation requiring wide diversification occurs when an investor who does not understand the economics of specific business nevertheless believes it is in his interest to be a long-term owner of American industry. That investor should both own a large number of equities and space out his purchases. By periodically investing in an index fund, the know-nothing investor can actually out-perform most investment professionals. Paradoxically, when "dumb" money acknowledges its limitations, it ceases to be dumb.
On the other hand, if you are a know something investor, able to understand business economics and to find five to ten sensibly-priced companies that possess important long-term advantages, conventional diversification makes no sense for you. It is apt simply to hurt your results and increase your risk. I cannot understand why an investor of that sort elects to put money into a business that is his 20th favourite rather than simply adding that money to his top choice – the business he understands best and that presents the least risk, along with the greatest profit potential.
We believe that a policy of portfolio concentration may well decrease risk if it raises, as it should, both the intensity with which an investor thinks about a business and the comfort-level he must feel with its economic characterestics before buying into it.
John Maynard Keynes
As time goes on, I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one's risk by spreading too much between enterprises about which one knows little and has no reason for special confidence. . . . One's knowledge and experience are definitely limited and there are seldom more than two or three enterprises at any given time in which I personally feel myself entitled to put full confidence.
I believe now that successful investments depends on three principles:
A careful selection of a few investments (or a few types of investment) having regard to their cheapness in relation to their probable actual and potential intrinsic value over a period of years ahead and in relation to alternative investments at the time
A steadfast holding of these in fairly large units through thick and thin, perhaps for several years, until they have fulfilled their promise or it is evident that they were purchased by mistake
A balanced investment position, i.e. a variety of risks in spite of individual holdings being large, and if possible opposed risks (e.g. a holding of gold shares among other equities, since they are likely to move in opposite directions when these are general fluctuations.