Where I disagree with Buffett and Munger

(PS: this is not a click-bait, I do indeed disagree with Buffett and Munger 🙂 )

Dear Readers,

It has been very difficult to make time to blog in the recent few weeks. However, I am hopeful that things should improve on that front and should be able to make some time towards my passion for writing on my favorite subject i.e. dividend growth investing.

I was thinking of what would be a good topic to write about for my next post, and after a lot of thought, I decided to pick a rather controversial topic: the one about diversification vs concentration in a portfolio. Simply put, if you are investing your capital in a few businesses, should you focus your bets on a few stocks that you understand very well OR should you diversify your investments across a few sectors with the knowledge that you may not necessarily be an expert on each and every one of them.

This has been a long standing debate in the world of investing. And like with every debate on investing, it too evokes strong opinions. I happened to be discussing this subject with a friend of mine and while he and I agreed that diversification is the way to go for the average retail investor, he cited how two of the most famous and successful investors of our time, Warren Buffett and Charlie Munger, were against diversification.

So I decided to do some digging and found the following video from the 1996 Annual Berkshire Hathaway meeting, where one the shareholders puts this very question to Buffett and Munger. Check out the video below:

To quote Buffett on this (pay special attention to that statement in bold, we will revisit it soon):

But I can assure you that I would rather pick — if I had to bet the next 30 years on the fortunes of my family that would be dependent upon the income from a given group of businesses, I would rather pick three businesses from those we own than own a diversified group of 50.

So clearly Buffett does not believe in diversification and instead recommends a concentrated portfolio consisting of businesses that one understands very well.

I am going to take a contrarian stance and disagree with Buffett here from the perspective of the average investor. In my humble opinion, this is terrible advice for the average retail investor. Now I know what you might be thinking: what do I know in comparison to Buffett, one of the greatest investors of all time. Sure, I may not be as successful as Buffett, but what I do understand very well are my limitations as a regular Joe investor. Hear me out here for a second and then you can make up your mind.

I contend that how you and I understand and evaluate businesses is drastically different from how Buffett and Munger understand businesses. So when they claim that they understand a particular business well, it is NOT the same as my claim that I understand a business well. We both may understand a specific business in our own limited capacities. In fact, their knowledge base is so profound that their knowledge will vastly outweigh mine.

For these reasons, it makes very little sense for Buffett and Munger to diversify. Similarly, it makes very little sense for the average retail investor to NOT diversify.

To drive home this point further, fast forward to the 2021 Annual Berkshire Hathaway meeting. Here is a video for your reference ( between 13:34 and 16:54). In the meeting, Buffett shares a list of the top 20 companies (by market cap) in 2021 and asks his audience to guess how many of these companies figured on a similar list back in 1989. He then shares the second list with the audience from the year 1989. Here are the snapshots of the two lists for your reference:

Notice that none of the companies from the 1989 list are on the 2021 list. In fact, you may have not even heard of several of the companies in the 1989 list.

So, following Buffett’s advice, if I as a regular retail investor, were to simply invest in three businesses that I *thought* I knew well in 1989, imagine how that would have turned out for me? To make matters even worse, I looked at a similar list for 2000, nearly ten years after 1989. You can check out the list here. Once again, apart from General Electric and Exxon (prior to its merger with Mobil Corp.), the top 10 list looks drastically different.

Interestingly, in the 2021 Berkshire Hathaway meeting, Buffett goes on the advocate for low-cost index funds.

One thing it shows incidentally is that it’s a great argument for index funds is that the main thing to do is to be aboard the ship. A ship. They were all going to a better promised land, you just have to know which one was the one that necessarily get on. But you couldn’t help but do well. If you just had a diversified group of equities, US equities, that would be my preference, but to hold over a 30 year period.

I recommend the S&P 500 index fund, and have for a long, long time, to people. And I’ve never recommended Berkshire to anybody, because I don’t want people to buy it, because they think I’m tipping them into something I’d never. No matter what it was selling for. And I’ve made it public. On my death, there’s a fund for my then-widow, and 90% will go into an S&P 500 index fund, and 10% in treasury bills.I like Berkshire, but I think that a person who doesn’t know anything about stocks at all, and doesn’t have any special feelings about Berkshire, I think they ought to buy the S&P 500 index.

So did Buffett change his stance? Well, I am not sure. But I would agree with the Buffett of 2021, in that index funds are the perfect solution for someone who does not know what he/she does not know about stocks and businesses.

Let me know your thoughts below. Regardless of whether you agree or disagree with me, I would like to hear your opinions on the subject.

7 thoughts on “Where I disagree with Buffett and Munger

  1. Another way to look at it is their weight in foreign versus US companies from then to now. In 1989 I think they underestimated the strength of the U.S. economy and his endorsement today of an index fund from my perspective is his betting on a continued strong US economy.

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    1. Yes, you are correct. He was also speaking about this in the context of “Don’t bet against America”. And that is a reasonable proposition. However, I would not agree with his and Munger’s stance against diversification. The problem really is that the average retail investor takes their word as gospel and simply clones their strategy. It is dangerous advice especially considering that it can be misunderstood quite easily.

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      1. They also have more financial tools/assets at their disposal that allows them to take advantage of opportunities that you and I as investors do not have and could never negotiate. Diversification is one of the few things we have at our disposal.

        Liked by 1 person

  2. I will disagree here. When we talk about limitations on our investing knowledge, are we saying that we have a cognitive limitation for critical thinking that Buffet/Munger don’t have? This comes down to who is willing to put the time and effort into learning how to invest in the same way that Buffet/Munger learned how to do it. Mohnish Pabrai (a very successful investor) will unashamedly admit that he is a copycat investor. He learned how Buffet/Munger did it, learned the method and applied it. Why can’t we all do the same? Not because they have massive IQs and we don’t (something Warren has talked about many times), but because they are willing the put the time and effort into the method and most are not. It’s not about intelligence, its about sheer force of will to do something extremely well. Appetite for success is the key here – not know-how. I have a portfolio of less than 10 holdings and I am doing very well with it. People say I am not diversified. I am diversified enough if I am holding solid companies with great fundamentals that I have deep knowledge of.

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    1. Hey Manny, Thank you for stopping by and dropping a comment. I really do appreciate the comment especially when it is a disagreement. It keeps the discussion rather stimulating and we all get to learn something when we are challenged on our views. Coming to your comment: you make some very valid points. But just to be clear, it is not solely about limitations when it comes to investing knowledge that hampers the lowly retail investor, but a multitude of other factors. Like SD Growth correctly pointed out, investors like Buffett and Munger have access to tools/information that normal retail investors simply would not have access to. They can talk to CEOs directly, they are on the board of several other companies etc. They have a team of analysts doing research. They have funds at their disposal for such research. The other important aspect is that of time. Buffett has admitted that he spends his entire work day reading 10Ks. A typical retail investor like me would have a regular day job and other family responsibilities and therefore very little time to delve into 10Ks in the same manner as someone like Buffett. So when they claim that they claim to know/understand a business, it is a LOT different than someone like me. Re: Mohnish Pabrai and his cloning strategy, I have written previously about how this in itself can be dangerous advice (atleast if the trades are copied blindly). Your reasons to invest in a business could be very different from why Buffett and Munger have invested in them. So you better be knowing what you are doing, which ultimately boils down to first point about knowing what you are owning. I admit that diversification for the heck of it is probably not a wise strategy and maybe this is what Buffett was trying to explain in his answer. I still think it is dangerous advice and something that can be easily misinterpreted.

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