Sometimes, learning from the best can get you in trouble.
Warren Buffett knows how to invest. As chairman and CEO of conglomerate Berkshire Hathaway (BRK.A 1.18%)(BRK.B 1.30%), he has generated billions in investment gains for himself and Berkshire shareholders.
Interestingly, a quick review of the Berkshire Hathaway stock portfolio shows a striking lack of diversification. Some 75% of the conglomerate's stock holdings are concentrated in five domestic companies that operate in four economic sectors: Apple, Bank of America, Coca-Cola, Chevron, and American Express.
Given Buffett's track record of savvy investment decisions, you have to wonder why he doesn't spread out his risk more. If Buffett can do well without diversification, can you too?
Buffett on diversification
Buffett has described diversification as "protection against ignorance." And he's not wrong. Diversification is a risk-management strategy. You give yourself exposure to different stocks -- or sectors, asset classes, and geographies -- to ensure that no single one of them can bankrupt you.
There is a trade-off, however. The point of diversification is to offset losses, but you'll also offset some gains in the process.
Buffett isn't one to compromise on gains, probably because he doesn't have to. He has a few factors working in his favor. Sadly, his advantages don't apply to most investors:
Buffett has 80 years of investing experience and an unusual knack for picking good businesses. His nickname, "Oracle of Omaha," says it all.
Berkshire Hathaway has a conservative balance sheet, with $30 billion in cash and cash equivalents, plus another $75 billion in Treasury bills.
Outside of its stock portfolio, Berkshire Hathaway is a majority owner in more than 60 companies.
Why you should diversify
If you had Buffett's skill and funding, you might do alright with concentrated positions in just a few stocks. But it's very likely you don't have Buffett's expertise -- or billions in cash to back you up. In that case, diversification is a must. If you can't absorb catastrophic losses, take steps to prevent them.
You diversify across individual stocks to lessen the risk of each. You invest across multiple industries so that no input shortage or regulation change can sap your portfolio's value. You can also put your money into different economies for protection against a downturn here at home. And you can diversify into other asset classes -- say, cash and bonds -- for insulation against stock market crashes.
How to diversify
As a guideline, look to hold at least 20 individual stocks across different industries plus a percentage of cash or cash equivalents.
Or, for an easier alternative, invest in two or more index exchange-traded funds (ETFs), which help you diversify with less work. This strategy can be as simple or as complicated as you want it to be. A good starting point is a low-fee S&P 500 fund plus a short-term U.S. Treasury ETF. To that, you could add on funds for exposure to U.S. small caps, international developed countries, emerging markets, real estate investment trusts (REITs), alternative assets, and more.
Earn more money another day
Diversification smooths out your investment results and protects against the biggest of losses. Unless your nickname is "Oracle" or something similar, that protection is critical because you won't always make the right choice. When that happens, diversification keeps you in the game to earn more money another day.
Bank of America is an advertising partner of The Ascent, a Motley Fool company. American Express is an advertising partner of The Ascent, a Motley Fool company. Catherine Brock has positions in Coca-Cola. The Motley Fool has positions in and recommends Apple and Berkshire Hathaway (B shares). The Motley Fool recommends the following options: long January 2023 $200 calls on Berkshire Hathaway (B shares), long January 2024 $47.50 calls on Coca-Cola, long March 2023 $120 calls on Apple, short January 2023 $200 puts on Berkshire Hathaway (B shares), short January 2023 $265 calls on Berkshire Hathaway (B shares), and short March 2023 $130 calls on Apple. The Motley Fool has a disclosure policy.
The Motley Fool recommends the following options: long January 2023 $200 calls on Berkshire Hathaway (B shares
B shares
A share is defined as an ownership of equity in a corporation. Class B shares are known as a type of classification of common stock which may have more or fewer voting rights as compared to Class A shares. In the event of bankruptcy, Class B shares may have a lower repayment priority as well.
), long January 2024 $47.50 calls on Coca-Cola, long March 2023 $120 calls on Apple, short January 2023 $200 puts on Berkshire Hathaway (B shares), short January 2023 $265 calls on Berkshire Hathaway (B shares) ...
A: Five rules drawn from Warren Buffett's wisdom for potentially building wealth include investing for the long term, staying informed, maintaining a competitive advantage, focusing on quality, and managing risk.
The common rule of asset allocation by age is that you should hold a percentage of stocks that is equal to 100 minus your age. So if you're 40, you should hold 60% of your portfolio in stocks. Since life expectancy is growing, changing that rule to 110 minus your age or 120 minus your age may be more appropriate.
But what may astonish investors is the sheer size of the Oracle of Omaha's ownership stake. Warren Buffett owns an eye-popping 37.3% of Berkshire Hathaway.
What Is a 70/30 Portfolio? A 70/30 portfolio is an investment portfolio where 70% of investment capital is allocated to stocks and 30% to fixed-income securities, primarily bonds.
Warren Buffett once said, “The first rule of an investment is don't lose [money]. And the second rule of an investment is don't forget the first rule. And that's all the rules there are.”
If you're 70, you'd look at sticking to 40% stocks. Of course, there's wiggle room with this formula, and it's really just a way to get started. And for many older investors, a 50-50 split of stocks and bonds is what's preferred throughout retirement, and that's fine, too.
For most retirees, investment advisors recommend low-risk asset allocations around the following proportions: Age 65 – 70: 40% – 50% of your portfolio. Age 70 – 75: 50% – 60% of your portfolio. Age 75+: 60% – 70% of your portfolio, with an emphasis on cash-like products like certificates of deposit.
There are no set ages to get into or to get out of the stock market. While older clients may want to reduce their investing risk as they age, this doesn't necessarily mean they should be totally out of the stock market.
We believe that Berkshire Hathaway, owing to its diversification and its lower overall risk profile, offers one of the better risk-adjusted return profiles in the financial-services sector and remains a generally solid candidate for downside protection during market selloffs.
A 0.30%) (BRK. B 0.33%) needs no introduction. The Warren Buffett-managed conglomerate has a stellar track record of growing value for its shareholders. It can make a great long-term investment.
Warren Buffett is the largest holder of Berkshire Hathaway (NYSE: BRK. A)(NYSE: BRK.B) stock. He owns around 227,416 shares of Class A stock, and 276 shares of Class B stock. These stakes combine for a value of roughly $136 billion, representing a 31.6% voting interest in the company.
The rule's origin is reported as advice given by Buffet to his personal pilot, Mike Flint. Flint asked Buffet for career advice, leading to Buffet thinking of the 5/25 rule. Buffet asked Flint to list his top 25 career goals, pick the top five, and avoid the rest until the top five are achieved.
They are: (1) Use specialist products; (2) Diversify manager research risk; (3) Diversify investment styles; and, (4) Rebalance to asset mix policy. All boringly straightforward and logical.
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