Here's One Warren Buffett Investing Strategy to Avoid

It's no secret that many investors regard Warren Buffett as one of the greatest investors of his time, and he's rightly earned that title. Buffett and his company, Berkshire Hathaway (BRK.A 1.00%) (BRK.B 0.79%), have consistently been part of the cream of the crop when it comes to returns over the years.

While investors who've mirrored Berkshire's portfolio have fared well, its strategy is one you should be cautious of following -- mainly because of how top-heavy its portfolio is.

What works for one won't work for all

In Berkshire's most recent 13F filing, it was revealed that its top five holdings accounted for over three-quarters of its stock portfolio.

Data source: Berkshire Hathaway 13F filings. Holdings data as of March 31, 2023. Portfolio percentage data as on June 27, 2023.

You can't deny it's worked for Berkshire, but having such a concentrated portfolio is risky and goes against one of the key pillars of investing: Diversification. With a concentrated portfolio, you could be more prone to volatility since a few companies' performances could significantly affect your overall portfolio.

In Berkshire's defense, Apple -- up well over 700% since Berkshire first reported its investment in first-quarter 2016 -- isn't a bad choice to have lead your portfolio. But that's much easier to say in retrospect. A concentrated portfolio works for Buffett and Berkshire for two main reasons.

First, they spend lots of time studying businesses in and out and have a deep understanding of the businesses they're investing in. The sheer number of hours they put into researching and valuing companies far outweighs what the average investor can (or wants to) do.

Berkshire also has a balance sheet that individual investors can't match. With its significant resources, such as having a cash pile of around $131 billion on its balance sheet, and non-stock holdings, Berkshire can weather market fluctuations and volatility that could pose serious risks to individual portfolios. 

Why diversification is important for investors

The classic saying "Don't put all your eggs in one basket" applies especially well to investing. Having a well-diversified portfolio helps reduce the risks and effects of stock market volatility. By spreading investments across various stocks and sectors, you can ensure your portfolio isn't too reliant on too few factors.

Keeping up with all the latest trends is also challenging for the average investor. Diversification is a way to get exposure to sectors or industries with growth opportunities you may have otherwise missed. It's much easier to keep up with sector trends that get a lot of media attention (like tech, for example) versus ones many people see as boring (like industrials).

You can view diversification as hedging your bets while maximizing your return potential.

An easy way to achieve diversification

There's no set number of stocks you should own for your portfolio to be considered diversified, but the Motley Fool recommends buying 25 or more companies over time. Unfortunately, doing this by investing in individual companies can be tedious because of the time it may take to research individual companies and industries.

A more efficient approach would be using an exchange-traded fund (ETF), which is a fund that contains many stocks within it and trades on a stock exchange like individual companies.

You could go with an S&P 500 ETF, which contains about 500 of the largest public U.S. companies by market cap. The S&P 500 includes companies from all major sectors and is the most popular index in the U.S. stock market.

You could also go with a total stock market fund, like the Vanguard Total Stock Market ETF (NYSEMKT: VTI), which contains over 3,800 stocks of all market caps, value, and growth potentials.

By investing in ETFs, you can cover a lot of ground with a few investments.

Your investments should be based on your goals

While Buffett's investing wisdom and results are undeniable, his and Berkshire's top-heavy approach may not be the best path for most investors. Understanding your own risk tolerance, financial goals, and time horizons is important before deciding what strategy makes sense for you.

For most people, the goal should be a balanced and diversified portfolio that can help lower risks and potentially offer more stable long-term returns. Soak in all the Buffett wisdom you need, but recognize that his strategies may not suit your financial circumstance.