Fund managers and financial experts often advise clients to broadly diversify their money across many different financial instruments such as stocks, bonds, currencies & money market funds. The logic is that by spreading your money into different areas, you reduce your risk.
Master Investors like Warren Buffett believe that although broad diversification reduces risk, it also reduces any potential of return.
If you invest in 50 stocks, then for your portfolio to double in value, you must find 50 stocks that double in value. That is almost impossible!
At the same time, by investing in so many companies and instruments, it is impossible for you to become an expert in anything. He believes that people diversify into everything to protect themselves against their own ignorance!
It's like asking the great tenor Pavoratti to diversify into 'Heavy Metal', 'Country & Western', Techno, Hip Hop and 'R&B' in order to reduce his risks in case he does not do well in Opera.
Instead, Warren Buffett believes in focusing all his money into a few, very well selected stocks that he knows will double in value.
He believes that an investor must only invest into a few companies that he understands very well and can track very closely. He calls it investing within your 'circle of competence'.
Does this mean that you should bet your entire savings on one or two companies?
Of course not! That is too dangerous. It is still important to spread your money across at least 8-10 stocks that you know inside out. However, once you buy more than that, it becomes harder to invest intelligently.
This information will not go down well with fund managers and financial experts, but master investors like Buffett do not apply strategies the ways the masses do which is why their results from investing cannot be compared with the master himself.
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