One of the most-repeated pieces of advice regarding the stock market is related to diversification. Most personal finance gurus argue that it’s important to diversify when investing. They argue that it’s better to put your eggs in several baskets than bet on only one and have it go bankrupt. This is often good advice, but a concentrated portfolio has its benefits, as well.
Concentrate on a Few Companies
Many successful stock investors like Warren Buffett and Charlie Munger have achieved market-beating returns by focusing on just a few companies. There is some evidence that once a portfolio reaches 15 or 20 stocks, it will tend to perform about as well as the market as a whole. To be sure, meeting market returns is good, but beating the market is better.
Build a Core
Today, Berkshire Hathaway owns several companies, and in recent years, its returns have approximated the market as a whole. Buffett accumulated much of his wealth in the past, and in the 1980s, there were years in which he owned as few as three issues. Another example of a concentrated portfolio is that of Carl Icahn, who holds 72% of his portfolio in only five different companies.
Building a core will require an avoidance of excessive dependence upon one sector of the economy. There will be some years in which consumer staple companies will beat tech stocks. There will be other occasions in which technology stocks will beat consumer stocks. Having a company or two from each sector could allow an investor to avoid the undue risk that can come from investing in only one sector.
Investors who have little time to research the companies they are buying will likely be better off just purchasing shares of a low-cost index fund. People who have the ability to read financial statements and understand the market forces that impact a given company can focus on those companies that are most likely to beat the market.
By focusing on high-performing stocks, it’s possible to beat the market with concentrated purchases of just a handful of companies. It’s still possible that one of the companies could go bankrupt, so it’s still a good idea to buy shares from more than one company. Concentration can be beneficial, but cultivating a concentrated portfolio has its risks, as well.