The Sage of Omaha, Warren Buffett, is on record saying he thinks most investors would be better off investing in an index tracker fund. But for the dedicated few, he has rather different advice.
Of course, we won’t out-perform the stock market with a tracker fund. Following the fortunes of America’s S&P 500, the UK’s FTSE 100 or FTSE 250 indices, for example, will help us match the stock market’s performance, not beat it.
Warren Buffett works punishingly hard
But Buffett thinks most people aren’t prepared (or able) to put as much effort into investing as he has. Alice Schroeder – his official biographer who wrote The Snowball — once said he works harder at investing than anyone she has ever known.
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I reckon most people will lack the time or inclination to obsess about investments as Buffett has. And tracker funds help minimise the risks involved with investing by providing wide diversification across many underlying businesses. I reckon there’s a good case for most investors having a sizeable chunk of their portfolio in trackers.
However, Buffett reckons wide diversification is counter-productive for those determined to work hard at their investment strategy with the goal of out-performing the markets. He once said: “If you really know the businesses you have bought, six wonderful ones is what you need to make you rich. Your seventh investment will dilute your returns.”
And Peter Lynch said something similar. He once managed the Magellan Fund at Fidelity and achieved annualised returns of just over 29% during his time running it. He said: “There don’t have to be more than five companies in a portfolio at any one time.” Both of these great investors reckon a concentrated portfolio may produce better returns. And I reckon a big secondary pay-off to such a strategy is it can consume less time to manage.
My hybrid approach
Although it has to be said that neither of those two ended up taking their own advice. Lynch ran a portfolio of around 400 positions at one time. And Buffett has his hands full managing his conglomerate, Berkshire Hathaway.
He also has portfolios of stocks with far more than five positions. But he did run a concentrated portfolio in his younger days. And back then, the returns from his portfolio were the greatest in annual percentage terms. Indeed, he often had as few as three to five positions.
I’d go for a hybrid approach. For me, it’s a good idea to build a core position in my portfolio featuring wide diversification. And I’d achieve that with tracker funds, investment funds and some selected managed funds. At the end of the day, my financial future depends on the success of my investments. And I want to protect myself from my own potential mistakes. But on top of that, a good chunk of my financial resources would go into a few hand-picked shares of individual companies.
If I out-perform the markets, all well and good. If I don’t, all’s not lost because of the backup from my other core, collective investments.
