There's success in the stock market, and then there's what famed investor Warren Buffett has managed to accomplish. Through his company, Berkshire Hathway (BRK.A 0.96%) (BRK.B 1.01%), Buffett and his partners have earned their rightful reputation as investing legends.
Their detail-oriented approach to evaluating companies and choosing stocks has led to top-tier returns over the decades, and the Berkshire stock portfolio is one investors often copy. However, there is one aspect of Buffett and Berkshire Hathaway's investing strategy that the average investor shouldn't replicate: the lack of diversification.
Below is a list of Berkshire's top five stock holdings:
| Company | Shares Owned | Percentage of Portfolio |
|---|---|---|
| Apple | 915,560,382 | 47.6% |
| Bank of America | 1,032,852,006 | 8.0% |
| American Express | 151,610,700 | 6.7% |
| Coca-Cola | 400,000,000 | 6.1% |
| Chevron | 132,407,595 | 5.9% |
Data source: Berkshire Hathaway 13F Filing / Data as of Aug. 14, 2023.
Although it's hard to argue with the results, having nearly half of your portfolio in one stock and almost three-quarters of it in five stocks is not ideal for the average investor.
The importance of diversification
Having a concentrated portfolio can often be a double-edged sword. When it works out, the upside is impressive, especially with the potential for some companies to become multibaggers. In Berkshire Hathaway's case, having Apple -- a company that's up over 600% since it first bought the stock in early 2016 -- be the foundation of its portfolio has worked out quite well.
The flip side is how devastating the losses can be in a concentrated portfolio when your top picks don't work out. Think about the plethora of stocks that have plunged 80% to 90% since their pandemic-fueled peaks. The stocks in the chart below were all Wall St. darlings with soaring share prices during the early stages of the pandemic. But anyone who put the bulk of their portfolio in these stocks based on their previous hype is likely staring down steep losses that could take years (or decades) to recover, if ever.
Data by YCharts.
One of the main reasons to have a diversified portfolio is risk management. By spreading your investments across many different stocks, you lower your exposure to any single company, industry, or sector. If one area suffers, the losses can be offset by gains in another, adding stability to your portfolio.
A diversified portfolio is also more likely to deliver consistent returns over the long haul. While you might not achieve the outstanding gains a concentrated portfolio can witness, you're also less likely to suffer devastating losses.
For the average investor, the objective is not to become a millionaire overnight but to grow wealth steadily and reliably. That makes the trade-off of a diversified portfolio well worth it.
Why concentration works for Buffett and Berkshire Hathaway
It's easy to look at Buffett and Berkshire Hathaway's results and think, "Well, if they can do it, so can I." And while you may be right, it's essential to realize their situation and the average investor's situation aren't comparable.
Buffett's investment strategy is tailored to his specific circumstances. Your investments should reflect your personal situation -- including financial goals, risk tolerance, and time horizon -- and chances are they don't align directly with Buffett's. This is particularly true when you understand the average investor simply doesn't have the same resources as a conglomerate like Berkshire Hathaway, which also owns many companies outright, further diversifying the overall business.
It doesn't take buying a lot of stocks for diversification
Buying individual stocks to achieve true diversification can be an overwhelming task. Luckily, you don't have to go that route. By investing in exchange-traded funds (ETFs), you can get a truly diverse portfolio with only a handful of purchases.
Buffett himself has consistently suggested that most investors would be better off investing in low-cost index funds, which are typically diversified themselves. His go-to suggestion has been an S&P 500 ETF like the Vanguard S&P 500 ETF because it tracks the 500 largest companies trading on U.S. exchanges and serves as a reflection of the U.S. economy for all intents and purposes. That can make it a true one-stop shop.
This approach simplifies the investing process and makes developing a well-diversified portfolio as easy as a few investments.
