In the world of investing, there's a constant tug-of-war between growth and value. Between diversification and concentration. Between large-cap and small-cap stocks. It's a game of trade-offs, where the individual investor must decide which strategy and qualities matter most to them.
If investing were a spectrum of risk, then diversification, large-cap, and value would be considered safer while concentration, small-cap, and growth could be considered riskier.
So how come Warren Buffett, the CEO of Berkshire Hathaway (BRK.A -1.78%) (BRK.B -1.89%), who is known for his prudent investing style, falls into both the large-cap and value "safe" categories, but he has set up Berkshire with a surprisingly concentrated portfolio? Here's why the strategy makes sense and how Buffett's portfolio allocation could help you become a better investor.
Buffett is one of the greatest investors of all time. The compound annual growth rate of Berkshire Hathaway between 1965 and 2021 is a staggering 20.1% -- which is one of the best long-term track records out there. The growth rate was closer to 30% during Buffett's earlier years when he managed less money and could take more risks.
Yet Buffett didn't get that outperformance by sticking with the status quo. He got it by thinking independently, making major bets on companies he believes in, and most importantly, sticking with many of those companies over the long term.
Today, Berkshire Hathaway owns $358.7 billion in public securities. Of that amount, 66% is concentrated in Apple, Bank of America, and American Express. Seventy-six percent is in the top five holdings. And 87% is in the top 10 holdings.
On the surface, having 45% of a portfolio in Apple stock may look extremely risky. But Buffett is known for his shrewd research, high conviction, and preference to go with only his best ideas. In his younger years when Berkshire was much smaller, Buffett invested in small-cap value stocks in a concentrated fashion. Today, he invests in large-cap value stocks. But throughout his career, Buffett has always stayed within his circle of competency, which is value investing.
Berkshire Hathaway is famous for buying back its own stock and doubling, tripling, and quadrupling down on its best ideas instead of buying other securities that the company doesn't believe in as much.
Berkshire began buying Apple stock in 2016 and has consistently added to the position since then. A more recent example is Berkshire's accumulation of Chevron and Occidental Petroleum stock, which, over the last few years, went from nonexistent in Berkshire's portfolio to its ninth and 10th largest holdings, respectively.
The lesson here is that if -- and this is a big if -- an investor puts in the time to know the ins and outs of a company, and they believe in that company long-term and want to keep following it closely over time, then it does make sense to go overweight into a handful of your best ideas.
Keep in mind that Buffett had the temperament not to sell his favorite companies during the 2018 U.S.-China trade war bear market, the COVID-19 crash of 2020, or even the recent sell-off. In sum, going with a highly concentrated portfolio over a largely diversified one makes sense for a specific kind of investor. However, you could argue that a larger, more diversified portfolio makes more sense than a concentrated one for folks who don't have time to keep up with the companies they hold or may lack the patience to stick with those companies in the event the market crashes.
More than meets the eye
It's worth mentioning that Berkshire's stakes in publicly traded securities can be a bit misleading. Berkshire Hathaway, which has a market cap of $785.2 billion or more than double the value of the public securities it owns, has major holdings in wholly owned insurance businesses, railroads, services companies, energy companies, utilities, and more.
In this vein, the "real" weighting of Apple among Berkshire's overall holdings is more like 20%. What's more, Berkshire produces earnings from its other businesses, which provide cash flows to keep the company running. Thanks to these other businesses, Berkshire is less like a fund and more like a conglomerate that operates different business units and invests extra cash into other companies.
The greatest lesson of all
Retail investors are more like Berkshire Hathaway than they may realize. If you're investing the right way, then you're doing it over a multi-year or probably multi-decade time horizon. Just like Berkshire, your income doesn't come from selling stocks, but rather, from your job or business.
For an investor who is interested in following a handful of companies and doesn't need the money they invest anytime soon, I think that operating a concentrated portfolio of your best ideas with companies you are passionate about is a great way to invest. However, there is absolutely nothing wrong with passive long-term investing in an index fund or a portfolio of 20, 50, or even 100 stocks if that lets you sleep better at night.