Diversification or concentration? To create wealth, concentrate; To preserve it, diversify. A concentrated portfolio can produce huge gains, if you own the right stocks. Of course, if you own the wrong ones, your wealth will be wiped out. Buying the right sector, at the right time, at the right price requires multiple factors, most of which are out of your control. The primary ingredient for consistently picking a winning stock is luck.
Let’s look at the best performing sectors for the last 10 years and the returns they generated.
2008: Long term bonds = 33.92%
2009: Emerging Markets = 76.28%
2010: Real Estate = 28.37%
2011: Long term bonds = 33.96%
2012: International Small Cap Stocks = 21.28%
2013: U.S. Small Cap Stocks = 41.32%
2014: Real Estate = 30.36%
2015: International Small Cap Stocks = 9.10%
2016: U.S. Small Cap Stocks = 26.61%
2017: International Small Cap Stocks = 32.73%
2018 U.S. Small Cap Stocks = 14.47%
It might appear easy to pick the winner in advance, but this is not the case. For example, the emerging markets rose 76% in 2009, but lost 51% in 2008. How many investors had the courage or wisdom to invest in emerging markets in 2008? If they did, they were rewarded handsomely one year later.
International small-cap companies have been the best performing sector for 3 out of the last 10 years, so it would make sense to allocate some money to this sector. However, it does come with risks because it generated negative returns in 2008, 2011, and 2014.
Warren Buffett prefers a concentrated portfolio and it doesn’t pay to argue with the greatest investor of all time. Mr. Buffett concentrates his wealth in Berkshire Hathaway stock. Is Berkshire a concentrated or diversified holding?
Let’s look at some of the holdings listed in the 2017 Berkshire Hathaway annual report.[1] Berkshire owned the following publicly traded companies: American Express, Apple, Bank of America, Bank of New York, BYD Company, Charter Communications, Coca-Cola, Delta Airlines, General Motors, Goldman Sachs, Moody’s, Phillips 66, Southwest Airlines, U.S. Bancorp and Wells Fargo.
In addition, Berkshire also owned several privately held companies, including: Acme Brick, Ben Bridge Jeweler, Benjamin Moore, Brooks, Borsheim Jewelry, Burlington Northern, Clayton Homes, Duracell, FlightSafety International, Fruit of the Loom, GEICO, General Re, Helzberg Diamonds, Johns Manville, Jordan’s Furniture, Justin Brands, Kraft Heinz, Lubrizol Corporation, Marmon Holdings, McLane Company, MidAmerican Energy, MiTek Industries, NetJets, Nebraska Furniture Mart, Oriental Trading Company, Pampered Chef, Precision Castparts, Precision Steel Warehouse, Scott Fetzer Companies, See’s Candies, Shaw Industries, and Star Furniture.
Is his portfolio concentrated or diversified? I’ll let you come to your own conclusion, but I think it’s the later.
A balanced portfolio of 60% stocks, 40% bonds generated a 6.93% return for the past 10 years – including the sharp drop in 2008. A million-dollar investment on 8/1/2008 is worth $1.97 million today.[2]
It would be great, and financially rewarding, to always invest in the best investment but this is not possible. For most investors, a diversified portfolio of low-cost mutual funds is recommended. Your portfolio will benefit from the long-term growth generated from global markets.
I am not saying this because I am in need, for I have learned to be content whatever the circumstance. ~ Philippians 4:11
9/27/2018
Bill Parrott is the President and CEO of Parrott Wealth Management firm located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process.
Note: Investments are not guaranteed and do involve risk. Your returns may differ than those posted in this blog.
[1] http://www.berkshirehathaway.com/subs/sublinks.html
[2] Morningstar Office Hypothetical – 8/1/2008 – 8/31/2018. IVV, IJR, EEM, EFA, AGG. Returns are gross of fees and taxes.