I’ve been going over Buffett’s Lecture at the University of Florida from 1998. I believe it’s one of his better lectures, maybe because his answers are less scripted than in recent years. You still hear the themes he repeats today only his answers are more in-depth.
One of the questions offered to him is about diversification, which I found interesting. His answer is one he’s repeated several times since in a similar form, yet for some reason it stands out.
If you are not a professional investor, if your goal is not to manage money in such a way so that you get a significantly better return than the world, then I believe in extreme diversification. I believe 98% – 99%, maybe more than 99% of people, who invest should extensively diversify and not trade. So that leads them to an index fund type of decision with very low costs. All they are going to do is own part of America. And they made a decision that owning a part of America is worthwhile.
I don’t quarrel with that at all. That is the way they should approach it unless they want to bring an intensity to the game to make a decision and start evaluating businesses. But once you’re in the business of evaluating businesses and you decide that you are going to bring the effort and intensity and time involved to get that job done, then I think that diversification is a terrible mistake to any degree. I got asked that question when I was at SunTrust the other day. If you really know businesses, you probably shouldn’t own more than six of them.
If you can identify six wonderful businesses, that is all the diversification you need. And you will make a lot of money. And I will guarantee that going into a seventh one is going to, rather than putting more money into your first one, is gotta be a terrible mistake. Very few people have gotten rich on their seventh best idea. But a lot of people have gotten rich on their best idea.
So I would say for anyone working with normal capital who really knows the businesses they have gone into, six is plenty, and I probably have half of it in what I liked best. I don’t diversify personally. All the people I know that have done well with the exception of…we mentioned Walter Schloss earlier. Walter diversifies a lot. He owns a little of everything. I call him Noah, you know, he has two of everything.
I’m sure a lot of people will focus on the number 6. Six sounds simple. And for Buffett, it might be. But 99% is the more important number.
This is the earliest I’ve seen Buffett recommend index funds, that I can remember. And I’m almost certain that’s the last piece of advice someone would listen to in the midst of the Internet boom. Especially, when you consider the audience of business students. And yet…
It’s the best advice Buffett offers.
Buffett’s main point revolves around hard work. Ben Graham understand this by dividing investors into two types – enterprising or defensive – decades ago. Many investors dive into the deep end without asking themselves if they even want to swim.
The time and effort – the “intensity” – not to mention patience and discipline, involved in finding and waiting for those six stocks is hard. Unbelievably hard. Yet, people try (fail) all the time without putting forth any effort. What Buffett is suggesting is a full-time job and the results are not guaranteed without the right behavior.
Which makes Buffett’s reference to Walter Schloss all the more interesting because Schloss took the opposite approach to what Buffett is saying and did very well for himself.
Buffett has praised Schloss before. The first time was in his The SuperInvestors of Graham and Doddsville speech. Schloss had a knack for focusing on a few simple criteria – companies with a low P/B, low debt, and a track record over a 10 to 20 years – that placed small bets on a little over a hundred companies. It was a simple repeatable process. Having a repeatable process requires less work since it can be automated to some degree through ETFs and/or a rules-based system.
Schloss is a good example of an investor who understood his strengths and weaknesses and built a strategy on what was best for himself. As he said, “It fits our personality”:
We do it our way for several reasons: it fits our personality; it avoids stress, and for me, I remember the Depression of the 1930s very clearly and how it affected our family. People who have been laid off in recent years won’t forget what has happened to them and their families, and it will affect how they or their children will act in the future. As they say, if the other fellow is laid off it’s a Recession, but if you are laid off it’s a Depression. I never want this to happen to my family, and so Edwin and I look for ways to protect us on the downside and, if we are lucky, something good may happen. We are basically passive investors.
You don’t find this type of honest self-reflection very often. Investing has always been about understanding yourself, what you’re capable of, knowing the amount of work you’re willing to do, knowing how you will act during the swings in the market, and building a strategy fit for you. Schloss’ unwavering commitment to what worked for him certainly brought him luck. (over the 40 year period from 1956 to 1995 Schloss earned his limited partners 15.7% per year compared to 10.4% for the S&P 500).
- Putting Clients Second – J. Bogle
- My Interview with Jason Zweig – Safal Niveshak
- Oaktree’s Marks on Cautious Investing, Market Forecasting (video) – Bloomberg
- Mind the Gap Between Academic Research and Practice – Morningstar
- 39 Books Charlie Munger Says Will Make You Smarter – S. Parrish
- The Making of a Brand – M. Housel
- There is One Quality that Builds Trust and Loyalty – BBC
- Companies That Stay Silent On Political Issues Can Pay A Hefty Price – Fast Company
- Apple: The Greatest Cash Machine in History? – Musings on Markets
- Inside Apple’s New “Spaceship” Campus – Reuters
- Serial Killers Should Fear This Algorithm – Bloomberg