During a Berkshire Hathaway shareholder meeting a few years ago, Warren Buffett and Charlie Munger were asked a straightforward yet revealing question: If someone in your local town owned three to five businesses, such as a cake shop and a dry cleaner, you'd probably think they were pretty well diversified. So why do financial experts often recommend holding 20 to 30 stocks in a portfolio? The questioner was curious about Buffett's views on diversification and how he approaches concentrating his investments.
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Buffett didn't hesitate to challenge the conventional wisdom. He made it clear that while owning a broad range of stocks is often recommended, it's more of a safety net for those who don't know how to evaluate businesses properly. "Diversification is a protection against ignorance," Buffett said. "If you know how to analyze businesses and value businesses, it's crazy to own 50 stocks or 40 stocks or 30 stocks." In other words, if you've done your homework and truly understand a few outstanding companies, spreading your bets across dozens of stocks might dilute your returns.
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Buffett isn't just speaking theoretically. He practices what he preaches. At one point, he mentioned that he owns just one stock in his portfolio – the one he knows best. And when it comes to Berkshire Hathaway, he's perfectly comfortable with concentrating investments in just a few stellar businesses. "I could pick out three of our businesses, and I would be very happy if they were the only businesses we owned and I had all my money in Berkshire," he added.
Then Charlie Munger, never one to shy away from a blunt opinion, chimed in. He didn't just challenge modern financial theories; he flat-out dismissed them. "Much of what is taught in modern corporate finance courses is twaddle," Munger declared, eliciting laughter from the crowd. His point? Complex models and theories might sound impressive but often add little value to real-world investing.
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Munger also emphasized the importance of sticking with what you know. "If you find three wonderful businesses in your life, you'll get very rich," he said. And unlike the intricate theories taught in finance classes, this approach is simple, straightforward, and, according to Munger, far more effective.
Buffett and Munger's advice is clear: If you truly understand the businesses you're investing in, you don't need to spread your money across dozens of stocks. Instead, concentrate on a few outstanding companies that you know inside and out. Diversification can help you avoid major mistakes, but it might also prevent you from achieving the extraordinary results of deep, focused investments in just a few high-quality businesses.
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So, the next time you're building your portfolio, remember Buffett and Munger's wisdom. Don't let the fear of risk lead you to dilute your potential returns. Instead, focus on finding those few great companies you understand and believe in – and then, as Munger might say, ignore the twaddle.
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This article Want to Get 'Very Rich'? Charlie Munger and Warren Buffett Say You Only Need 3 Wonderful Businesses – Not 30 Stocks originally appeared on Benzinga.com
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