You don't get to be as revered an investor as Warren Buffett by accident. Developing his cultlike following has taken decades of timeless advice and the results to match it. Through his company, Berkshire Hathaway (BRK.A -0.76%) (BRK.B -0.69%), Buffett has achieved once-in-a-generation investing success.
Berkshire's stock portfolio consists of 50 companies, but they're far from weighted equally. Here are its top five holdings:
| Company | Number of Shares Owned | % of Berkshire Hathaway's Holdings |
|---|---|---|
| Apple | 915,560,382 | 46.5% |
| Bank of America | 1,032,852,006 | 8.3% |
| American Express |
151,610,700 | 7.1% |
| Coca-Cola | 400,000,000 | 6.4% |
| Chevron | 132,407,595 | 5.3% |
Data source: Berkshire Hathaway 13F filing. Holdings as of March 31, 2023. Portfolio percentages as of July 18, 2023.
Considering how many companies Berkshire owns a stake in, I was shocked to see the top five accounted for almost three-quarters of the entire portfolio. To be fair, there's no denying this strategy has worked so far for Berkshire, and having your top holdings in all blue chip stocks isn't the worst thing an investor could do. It's still not ideal for the average investor, though.
While a close study of Buffett's stock picks can be helpful to any investor, the portfolio at Berkshire represents a "do as I say, not as I do" situation (I'm sure parents understand that wholeheartedly).
Why investors should avoid highly concentrated portfolios
Stock market investing is risky enough. Having a concentrated portfolio adds to this risk and goes against one of the pillars of investing: diversification.
When your portfolio is highly concentrated, you're vulnerable to conditions hurting a particular sector, industry, or company. For example, if your portfolio were concentrated in bank stocks this year, you'd probably be underperforming the market due to the banking crisis earlier in the year. The same applies to consumer discretionary companies, which have been impacted by higher inflation.
The opposite is also true. Concentrated portfolios can thrive when heavy hitters lead the way (as in Berkshire's case with Apple), but that can only be said in retrospect. There's no predicting exactly how specific stocks will behave, but you can do your job to hedge risks where possible.
Potential exposure to overlooked opportunities
Diversification also has the underrated benefit of exposing investors to sectors or industries with growth opportunities they might have otherwise overlooked.
It's relatively easy for someone to keep up with tech trends like artificial intelligence because they get most of the media coverage and investor attention. It takes a bit more work for someone to keep up with trends in sectors like healthcare and industrials. Considering they're the third- and fourth-best performing S&P 500 sectors over the past decade, respectively, it would indeed be helpful if investors were up to speed on them.
And therein lies the advantage of a diverse portfolio that includes exchange-traded funds (ETFs) spanning all sectors -- you don't necessarily have to follow every corner of the market.
Why not follow Berkshire Hathaway's lead?
A concentrated portfolio works for Berkshire and not the average investors for a few reasons. First, the average investor doesn't have comparable resources, time, or expertise to what Buffett, Charlie Munger, and the rest of the team at Berkshire do.
By no means does it make them immune to bad decisions, but they're working with a much deeper understanding of businesses, the competitive landscape of industries, valuation models, and other factors when making intentional choices to go with such a concentrated portfolio.
The second reason comes down to bank accounts. Berkshire is a $750 billion business with over $130 billion in cash, cash equivalents, and short-term investments. This financial strength puts Berkshire in a position to weather virtually any economic conditions and thrive through times of high volatility.
The same can't be said for the average investor. If things turn sour, too much concentration in a portfolio could jeopardize an investor's livelihood.
It doesn't take much to get a diversified portfolio
While The Motley Fool recommends that investors own at least 25 stocks for their portfolios to be diversified, that doesn't mean you have to buy 25 individual stocks. Investing in ETFs like those built around the S&P 500 or Nasdaq Composite is often a better route. A single investment can give instant exposure to hundreds or thousands of companies.
You can find total stock market ETFs, sector-specific ETFs, ETFs specific to your investing style, and many other categorizations. Instead of picking winners in an industry, you can invest in the industry as a whole. The same goes for a fund like the S&P 500, which is essentially an investment in the broader U.S. economy.
You might not see huge rallies in a well-diversified portfolio like you can with a concentrated one, but you also have a natural safety net that ensures you're better positioned for long-term success.
