Why diversify

"There is no time to be reading a book on the theory of diversification. That is a time to take your thumb out of your mouth and barrel in — when you find something within your circle of competence, where you understand the business, the price is right, and the people are right."

There is no time to be reading a book on the theory of diversification. That is a time to take your thumb out of your mouth and barrel in — when you find something within your circle of competence, where you understand the business, the price is right, and the people are right.

Even the most careful analysis can be wrong: diversification does not raise the expected return of a single idea, it limits the damage if that idea turns out to be wrong.

Even when you've done the homework - read the three financial statements, worked out the margin of safety, checked the composite score - a company can still surprise you for reasons no analysis predicts: a lawsuit, a change in regulation, a product that fails, an executive who leaves at the wrong moment. Diversifying doesn't stop these events, which stay unpredictable by definition: it stops any single one of them from deciding the fate of your whole portfolio.

Diversifying isn't just about owning many different companies: it's about owning companies that don't all respond to the same risk. Twenty companies in the same sector look like twenty different bets, but if something hits that sector - a regulation, a rate change, a drop in demand - it hits nearly all of them at once. Looking at each position's sector, not just the number of positions, is what makes diversification real instead of just apparent.

It's worth being honest about one point: Buffett himself, speaking to university students, pushed hard in the opposite direction - when you find an idea within your circle of competence, at the right price, his advice is to bet big on it, not stop to theorize about diversification. That advice holds for someone who is certain they've truly understood the business. Diversifying is the honest admission that, for most ideas, you don't have that absolute certainty - and that it's worth building yourself a safety net for when, not if, some estimate turns out wrong.