The Power of Concentration: Rethinking the "Don't Put All Your Eggs in One Basket" Mantra - 2017

We've all heard the saying: "Don't put all your eggs in one basket." It's a common piece of advice, especially when it comes to investing. But is it always true? I'd argue that it depends. The saying holds true if you're careless or uninformed. But if you know what you're doing, concentrating your investments can be safer and more efficient.

Think about it: modern technology has revolutionized how we handle eggs. Farmers don't use baskets anymore! They use specially designed egg trays that absorb shock and vibration, allowing them to transport huge quantities of eggs safely in one go. This is the power of knowledge and continuous improvement. Similarly, in investing, deep understanding can minimize risk. If you truly understand the company you're investing in, you can significantly reduce the chances of making a bad investment.

Many investors lack self-confidence, so they try to mitigate risk by buying a little bit of everything. They hope that some of their stocks will be winners, and that one bad apple won't spoil the whole bunch. This approach reveals a lack of due diligence. They haven't done their homework, they haven't thought independently, and they don't truly understand the companies they've invested in. I've shared many qualities of a good company, and it's essential to stick to those standards.

A concentrated portfolio, where you invest in a smaller number of companies, can lead to higher volatility. One big win can significantly boost your returns, while a poor performance from a single stock can drag down your overall portfolio. But don't let volatility scare you. If you've chosen good companies, be patient. Think of it like a mango tree. You can't expect a bountiful harvest after just a few months. Deeply research, choose wisely, and wait patiently for your investments to bear fruit. In the long run, a concentrated approach can yield much better returns, potentially exceeding 10% annually. However, remember that any single year's return might not look so impressive. That's perfectly normal. My own portfolio, for example, is highly concentrated – at one point, 80% was in a single stock! This makes it volatile, but it also has the potential for strong returns because I focus on quality companies.

I often observe other investors and bloggers. Many hold more than 15, even 30 or more different stocks. I struggle to understand how they can possibly dedicate the time and effort needed to thoroughly research and understand so many companies. Do they truly have the circle of competence to evaluate such a wide range of businesses? A large number of holdings can often lead to average returns, similar to a unit trust that invests in hundreds of companies. It's rare to see these portfolios achieve truly outstanding returns, like 30% or more in a single year.

Warren Buffett has criticized this approach. He argues that many fund managers, driven by peer pressure and the need to protect their jobs, play it safe. They diversify broadly, not necessarily to maximize profits, but to avoid looking too bad when the market declines. This strategy also prevents them from standing out when the market performs well. The result is often mediocre returns. This is why independent thinking and wise action are so crucial. Don't blindly follow the crowd. In the investment world, as in life, it's essential to think for yourself.

Diversification, as Warren Buffett has said, is a protection against ignorance. It's less necessary if you know what you're doing. Furthermore, companies themselves often have internal diversification. As Philip Fisher pointed out, a company might diversify geographically or across different customer segments. So, you don't need to diversify just for the sake of diversification. Focus on understanding the businesses you invest in, and let them do the diversifying for you.