While Warren Buffett has achieved a tremendous amount during his investing career, he is not infallible. Just like every other investor, he has made mistakes and underperformed at times.
Of course, his strategy of having a concentrated portfolio has worked well for him. As has his focus on larger stocks with wide economic moats. Similarly, having a significant amount of cash on hand has also helped him to take advantage of investing opportunities. But does this necessarily mean that what works for Buffett will work for your retirement savings plans?
Warren Buffett has stated that investors should beware of over-diversification. Essentially, this means that investors are sometimes so worried about the potential for negative returns from individual stocks they are holding that they bulk-out their portfolio with a large number of shares. Although this reduces company-specific risk, it does not reduce market risk. As a result, there is still scope for a significant loss if, for example, the economic outlook for a specific region deteriorates in a short space of time.
Furthermore, Buffett argues that by over-diversifying it is possible to dilute potential returns. After all, an investor’s ability to outperform the market becomes more difficult as a portfolio moves closer to being a tracker fund. As such, the Sage of Omaha argues that in order to generate high returns, it may be better to hold a limited number of shares.
While there is merit in this idea, the reality is that many investors find it challenging to overcome setbacks and losses within a portfolio. And while diversification can reduce rewards, its impact on lowering risk can mean this is a worthwhile compromise to make.
Many of Buffett’s biggest investments have been made in larger companies. They provide a larger competitive advantage versus their smaller peers since they often have stronger balance sheets, a higher degree of customer loyalty and scale benefits, which makes them more efficient.
However, larger companies also lack the growth appeal of their smaller counterparts in many cases. This can mean that the returns on offer from smaller firms are generally higher over the long run. And with many investors still a long time away from retirement, it could be argued that holding small-caps is a sound move, since there is likely to be time for them to recover from a possible downturn.
Of course, small and large companies can be held together in a portfolio. For many investors, holding both types of stocks could be a worthwhile move, since they may provide a stronger risk/reward ratio than when they are held in isolation.
Buffett’s view on cash is fairly simple: have lots of it at all times. The main reason he adopts this attitude towards cash is so that he has capital available should opportunities for investment arise. As a result, he is able to capitalise on major events that push share prices downwards, while others who are fully invested fail to take advantage of opportunities to generate high gains in the long run.
Of course, having too much cash can be detrimental to overall returns. Inflation is ahead of interest rates, and this could lead to a loss of purchasing power over the medium term. However, holding some cash is a good idea. It may provide peace of mind for investors who are otherwise lacking in liquidity, while also offering the opportunity to buy during bear markets.
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