Many great investors have concentrated portfolios. Concentration can be great if stock picks turn out well; however, 1 or 2 bad picks can sink your portfolio.

Here are some benefits/risks of concentration and standards to look for when concentrating one’s portfolio.

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Warren Buffett has said “If I were running 50, 100, 200 million, I would have 80% in five positions, with 25% for the largest.” As he puts it, if I had LeBron James on my team, why would my 20th player get any playing time? I should be investing most of my resources into LeBron.
Clearly, Buffett believes in the value of concentration. Like many great investors, Buffett chooses a few positions that he is very confident in, and he invests money in those. Consequently, he has consistently outperformed the market for decades.
On the flip side is Peter Lynch. Lynch has also crushed the market for decades; however, he at times owned over a thousand stocks! While most of us cannot keep up with 1000 positions, this shows that one need not be concentrated to beat the market.
Furthermore, there are dozens of risks that come with concentrating one’s portfolio. Over time, the average concentrated investor would have been significantly more likely to be crushed by the market.
In fairness, most good investors (and most of the investors I have interacted with on Fintwit) likely are not picking an 8 stock portfolio of stocks that will all go to 0, but the risk is certainly there.
Even Buffett notes some risks of concentration. For example, he asserts that if investors borrow money, invest in companies that can pull out the rug from under them, or buy companies they do not understand, concentration becomes a very slippery slope.
Based on the strategies of Lynch and Buffett, it is clear that both concentrated and diversified portfolios can beat the market. Regardless of your strategy, these great investors agree on some very clear rules to follow:
(1) Only buy what you know - One of Peter Lynch’s greatest insights, investors are at a huge advantage when they are actually users of or familiar with a company. Conversely, investors who do not understand their stocks are at a disadvantage to those who do.
(2) Do not borrow conviction - Fintwit is an incredibly valuable resource, yet every day, there are people on this platform raving about new stocks that will be the next 100-bagger. Do your own research and make sure you fully understand the company first.
(3) Have a process - Whatever world for you is great, but it is essential to know what you’re looking for in a company and be able to evaluate its attributes. See below for my process: https://twitter.com/ztinvesting/status/1271624860616265728
(4) Have high standards for what you buy - It is important to have strict, tested standards for what will be included in your portfolio. Do not bend those standards, and when a stock doesn’t fit, move on.
(5) Think 5,10,20 years into the future - When you evaluate a company, don’t just look at what it is now, but look at its vision for 10 years from now. Invest in those companies that have a vision for the future that most closely aligns with your own.
(6) Invest for the long term - whether concentrated or diversified, the portfolios that reward investors most over time are those built for the long term. Holding stocks for years and years allows you to compound growth and accumulate wealth.
Currently, I have a portfolio diversified among many stocks, but largely concentrated to tech, e-commerce, fintech, and software. I am in the process of removing some positions that are based off of borrowed conviction or that I don’t understand.
Funds from these stocks are being put into companies that I understand best and am most bullish on: $SE, $SQ, $STNE, $RDFN and so on. Everyone has a different strategy, so stick with what you know, and do what works for you, not for Buffett, Lynch, or some random guy on Twitter.
Thank you for reading. I would love to hear anyone’s thoughts or comments on diversification vs concentration.
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