"Wide diversification is only required when investors do not understand what they are doing."
In this clip, Warren Buffett talks mainly about diversification, therefore I will concentrate the content just on this topic. He also talks about the businesses of Proctor and Gamble and Coca-Cola and why they are great businesses.
Nevertheless, his response to the question on diversification was two-fold.
1. If you are not a professional investor and your goal is not to manage money so that you get a significantly better return than the world, then 98-99% of the people who invest should diversify. This is the only case where he firmly agrees with diversification. These type of investors should consider indexing.
2. However, if you want to bring intensity to the game; to make a decision and start evaluating businesses, then diversification is a bad idea. If you really know businesses, you shouldn't own more than six of them. Going into a seventh idea rather than adding to your best idea rarely makes sense.
"Diversification is insurance against ones own ignorance."
In an effort to stick to the simplicity of this idea, I will not dwell too much on it. I think it is self explanatory. If you are a sophisticated investor, then diversification may not be necessary. However, if you are not, you should diversify. The idea of diversification to minimize risk is what MBA students are taught in universities. Any finance course will tell you that unsystematic risk is reduced after owning about 15 stocks or so in a portfolio. However, this is dependent on your definition of risk. If you truly understand a business, then this whole philosophy of risk changes. You buy great businesses you understand with great economics, management at a very attractive price; what risk would there be? If you think volatility; well that only offers the opportunity to buy more at attractive prices.
"In the short run, the stock market is a voting machine, but in the long run, it is a weighing machine."
What does his philosophy on diversification teach us? I think it says that if you are absolutely certain about something, you should not fear putting a lot into it. For example, if I have studied a company, done all that I can to really understand the business, believe in the management, love the future economics of the company, then why should I hesitate to invest greatly in it. The returns will ultimately come. Consequently, if you truly believe in something, then give it your all, do not be afraid of risks or do not be tempted by what others may be doing, put your all in your best idea, in what you truly want to do with your life, and that is when you will be rewarded. If things do not work out the way you like, then at least you know that you did your best with it and that should be enough. Think about this greatly, diversification is almost another way of saying 'fear of failure or defeat'. Put your effort in what you truly want out of life, and chances are high that your desires will be fulfilled; you will see the returns. It just may not happen when you expect it to, but I assure you, it will happen in due time.
Check my blog posting on Napoleon Hill on The Power of the Mind.
Warren Buffett MBA Talk | Part 1: Integrity
Warren Buffett MBA Talk | Part 2: Smart Choices
Warren Buffett MBA Talk | Part 3: Choosing Businesses
Warren Buffett MBA Talk | Part 4: Share of Mind
Warren Buffett MBA Talk | Part 5: Circle of Competence
Warren Buffett MBA Talk | Part 6: Macroeconomic Factors
Warren Buffett MBA Talk | Part 7: Inactivity & Dividends
Warren Buffett MBA Talk | Part 8: Diversification
Warren Buffett MBA Talk | Part 9: Market Cap
Warren Buffett MBA Talk | Part 10: Ovarian Lottery