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Ask a Fool: Am I Diversified Enough?

By Matthew Frankel, CFP® – Jun 14, 2019 at 12:00PM

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Lack of diversification isn't necessarily bad, if it's for the right reasons.

Q: Most of my stock portfolio (about 75%) is concentrated in just three sectors of the market -- technology, banking, and consumer goods -- as these are the industries I know best. Should I diversify a bit more?

The short answer is not necessarily. About 60% of my own portfolio is made up of just two sectors: financials and real estate. Why? Those are the stocks I know how to analyze very well.

On the other hand, I don't understand healthcare stocks very well, and I just can't justify some of the current valuations in the tech sector, so these make up only a tiny portion of my portfolio.

One of my favorite pieces of Warren Buffett wisdom is this quote: "You only have to be able to evaluate companies within your circle of competence. The size of that circle is not very important; knowing its boundaries, however, is vital."

Buffett's investment strategy certainly lacks diversification in the traditional sense. Between the insurance companies Berkshire Hathaway (BRK.A -1.38%) (BRK.B -1.44%) owns and the many bank stocks in its portfolio, Buffett definitely favors the financial sector. And I don't know of any longtime Berkshire shareholders who have any problems with a lack of diversification.

The point is that it's completely fine to have a lack of diversification in your portfolio if the reason behind it is that you're very good at evaluating stocks in certain industries.

I will, however, say that it's important to diversify within your circle of competence. I own about a dozen real estate stocks, for example, and Berkshire Hathaway owns several different bank stocks. As long as you do this, sticking to what you know is a strength, not a weakness.

Matthew Frankel, CFP owns shares of Berkshire Hathaway (B shares). The Motley Fool owns shares of and recommends Berkshire Hathaway (B shares). The Motley Fool has a disclosure policy.

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