It is often said that you must diversify your investments in order to minimize risks, but according to Warren Buffett, you must put all your eggs in one basket in order to maximize returns. Which approach is best? Furthermore, how many stocks can a portfolio be said to be diversified? –Daniel Raymond
The debate between concentration and diversification is one of the oldest in finance. Some, like American billionaire Mark Cuban, argue that diversification is “for idiots.” Others, including Jack Bogle, founder of the Vanguard firm, believe on the contrary that it is essential to have a diversified portfolio to increase your chances of success.
Warren Buffett’s opinion falls somewhere in between. Buffett has previously said that if a professional manager is keen on trying to beat market returns, having a concentrated portfolio is the way to go. Buffett subsequently asserts that almost all “big and small” investors should instead choose diversified index funds, whose long-term returns have beaten those of more than 95% of professional managers, according to S&P analysis. Versus Active Funds Indices (SPIVA) published twice a year since 2002.1
At Berkshire Hathaway’s 2021 annual shareholder meeting, Buffett compared the top 20 global stocks by market capitalization in 1989 to the top 20 stocks in 2021. Result? None of the companies on the 1989 list were on the 2021 list.
“We are as confident today as Wall Street professionals were in 1989,” Buffett said. But the world can change very, very dramatically. This is a great argument for index investing. The important thing is to be on board the boat, because you can’t help but obtain good results if you have a diversified portfolio of stocks. »
Missing the boat can indeed be fatal: studies have shown that all of the long-term growth in the world’s financial markets comes from 1% to 3% of the securities traded there. Not having these securities in your portfolio means being condemned to tread water at best, and to suffer losses at worst.
Ian Gascon, president of Placements Idema, notes that diversification has long been part of his investment principles. “Very young, I started with three or four stocks in my portfolio, a bit like everyone else… But as soon as I started managing portfolios institutionally, I had a diversified index approach,” says -he.
In addition to performance difficulties, a concentrated portfolio will be more volatile because assets are spread across a smaller number of securities, notes Mr. Gascon. “Also, concentration requires higher involvement. You have to have a team of analysts, a lot of time… It’s not within everyone’s reach. »
For a portfolio to be diversified, it must contain at least fifty securities, he says. “To take maximum advantage of diversification, you can have a portfolio that includes hundreds or thousands of securities in several countries, several regions of the world, several different industries. Japan, Canada, United States, Europe: these are not the same sectors that are strong everywhere. »
An example of a diversified financial product is the Vanguard All-in-One ETF Stock Fund (VEQT), which includes the stocks of 13,686 companies in 51 countries. BMO offers a similar product under the ZEQT brand.
Such a portfolio would have produced average returns of 8.96% per year over the past 50 years, with returns of -38% in the worst year. A balanced portfolio of 60% stocks, 40% bonds (VBAL or ZBAL, for example), would have produced average annual returns of 8.46% for 50 years, with returns of -25% during the worst year, according to the calculations of Justin Bender, of the firm PWL Capital.2
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