Stock diversification is a mediocre way of investing. Warren Buffett doesn’t believe in it, Stanley Druckenmiller doesn’t, and neither do I. It is a poor and overrated investment strategy, and at 22 years old I am only focusing on a highly concentrated portfolio. More diversification within my investment portfolio will only lead to mediocre returns.
According to Warren Buffett, the greatest investor ever, “Diversification is a protection against ignorance, it makes very little sense for those who know what they’re doing to diversify.”
I am a young investor and only buy into concentrated ideas. Buying index funds sounds good and all to the average person but for me, I like to run my portfolio with 2-3 concentrated bets at a time. I have heavily researched these companies and calculated the possibility of their valuation doubling within the next 2-5 years. These bets can range across industries like software, products, and biotechnology.
Owning index funds like the $SPY is considered a safe way of investing. You will get your 8% a year and the manager of the ETF will pick and choose what stocks you indirectly own.
Here at FinancialFreedom101, we are looking to build a portfolio up with small-cap stocks that will give us a return of 200%, 400%, 600%, or over 1000% returns within 12-18 months. These are called “Multi-Baggers” since they are 2x, 4x, 6x, or over 10x their stock price.
Diversification is for investors who are not able to dedicate the required time to conducting research. Some individuals can provide themselves with nice returns over 15-20 years of investing in an ETF. But for FF101, we are looking to hit home runs and compound our portfolios in our early years of investing. We are looking for life-changing trades.
According to legendary investor Stanley Druckenmiller, who is worth 7 billion dollars, the most important thing that separates average investors from super investors is the ability to make big bets when you have a high conviction on a business as an investor.
In simpler English, the best investors spend their time researching 1 to 2 stocks at a time. Looking for the diamond in the ruff that will produce 200%, 400%, 600%, or over 1000% returns within 12-18 months. The trick is that these individuals will know more about the company’s operations, losses, deals, and movements than its own employees. They could probably run the company. This then gives them the confidence to make these large, high conviction bets.
This is what made Druckenmiller and Buffett such successful money managers. They knew what they were buying like the back of their hands. In some cases, Druckenmiller would do his own research and come to a conclusion, start an investment position in the company, and continue to follow the news/headlines to make sure his checkpoints were reached.
Then 1-2 weeks later Wall Street would come out with similar conclusions. Druckenmiller would already be invested and catch the upswing of all the Wall Street followers moving the stock price up. And as an added bonus, gets reaffirmed by Wall Street that his thoughts and conclusions are correct. Now imagine being quicker than Wall Street?
Druckenmiller once said “I have always made big, concentrated investments. I put all my eggs in one basket and watched that basket carefully. I don’t believe in diversification. I don’t believe that’s the way to make money. You are not going to make money talking about risk-adjusted returns and diversification. You’ve got to identify the big opportunities and go for them,”
Great article summarizing a recent Stanley Druckenmiller interview.
A small excerpt from the interview speaks on the idea of making large bets on high conviction bets.
Also, if you think about the top richest people in the world. People like Elon Musk, Bill Gates, and Jeff Bezos. Did they get their wealth from diversifying themselves? NOPE. Each one of them dedicated their lives to one idea, one large concentrated bet! And what happened? They became filthy rich. Now I am not saying you have to make the next Microsoft. But take this as a lesson in the sense that great wealth is achieved from BIG BETS.
Even look back to John D. Rockefeller, Andrew Carnegie, and Henry Ford. They didn’t diversify. John D. Rockefeller owned the whole oil industry, Andrew Carnegie had a monopoly on steel, and Herny Ford went all-in on the assembly line and cars. Ford had the idea to have every American buy his car the Model T.
On making concentrated, high conviction bets
Takeaway: The best investors (e.g., Warren Buffett, Carl Icahn, George Soros) make concentrated bets in high conviction plays. They don’t practice the business school teaching of “diversification”
Stanley Druckenmiller: “When I’ve looked at all the investors that have very large reputations — Warren Buffett, Carl Icahn, George Soros — they all have one thing in common.
And it’s the exact opposite of what they teach in a business school. It is to make largely concentrated bets where they have a lot of conviction.
They’re not buying 35 or 40 names and diversifying.
I don’t know whether you remember that Icahn a few years ago put $5B into Apple. I don’t think he was worth more than $10B when he did that.
[In 1992] when I went in to tell Soros that I was going to short 100% of the fund in the British pound against the Deutschmark, he looked at me with great disdain.
He thought the story was good enough that I should be doing 200% because it was sort of a once-in-a-generation opportunity.
So, [these investors] concentrate their holdings. This is very counterintuitive.
In my thinking, [concentrating your bets] decreases your overall risk because where you tend to be in trouble is if you have 35 or 40 names.
If you start paying attention to one. If you have a big massive position, it has your attention.
My favorite quote of all time is maybe from Mark Twain: “Put all your eggs in one basket and watch the basket carefully.”
I tend to think that’s what great investors do.”
We look for companies that will give us a multi-bagger return. When investing in small-cap stocks you have an edge over the rest of the market, you are looking in places nobody else is looking, and buying stocks before institutions are able to buy them. This is how Buffett was able to grow his money to exponential values in the 1940s and 50s, and this is how I want to run my investment portfolio.
Making concentrated bets is not for everyone. Much as concentrated bets become fashionable during good times, most people abandon the strategy again during bad times. Concentrated bets magnify market volatility, which can wipe out investors.
The best way to gain wealth is a concentrated portfolio, the best way to lose wealth is a concentrated portfolio. Diversification is to protect wealth once you have it. Take your returns and buy real estate.
You need five 10 baggers to change your life forever, and the only way you are finding those is in small caps.
Check out an awesome article here about an interview with Stanely Druckenmiller.