Diversification according to Warren Buffet (Part 1 of 2)

Warren Buffett is one of the most legendary investors in history. His success has much to do with his investment philosophy and methodology. That's why it's important to listen to what he has to say, but also to understand his words in the proper context.

Today I want to explore what he has said about diversification, a concept I have covered extensively in this space. Many Nobel Prize-winning experts consider it an essential tool for risk control in an investment portfolio.

Buffett, however, questions it without reservation. At Berkshire Hathaway's 1996 annual meeting, he said something that remains uncomfortable to accept: "Diversification as a practice makes very little sense to someone who knows what they're doing. It's protection against ignorance." And he didn't stop there: "If you don't understand business, diversify. But if you do understand business, why have 50 when three will do?"

His vision isn't new, but it is radical. Buffett doesn't view the market as a box of interchangeable assets. He sees it as a collection of real businesses. When he bought Coca-Cola, he didn't do it for its logo or its taste. Nor for its "growth potential" in the coming quarters. He did it for its franchise model, its global distribution, and its ability to generate cash flow without relying on fads. But even he acknowledged something practical: "There aren't 20 such companies. If there were, diversifying among them would be just as effective. But there aren't."

This is the crux of the matter. For Buffett, diversification only works if you have access to a large pool of clear opportunities. He doesn't need 100 companies because his approach is different: "An extraordinary business is protected against the economy and competition. Three of them are better than 100 average companies... and safer, too." But why? Because his methodology isn't speculative. It's analytical. If you deeply understand a business (its debt, its margins, its ability to withstand crises), what protects you more: a portfolio of 50 stocks you don't master, or three that you do?

The answer seems obvious, but there's a catch. Buffett doesn't reject diversification out of arrogance. He does so because his strategy is based on a different foundation: he doesn't buy stocks, he buys businesses. He doesn't analyze balance sheets: he understands them. He doesn't expect his stocks to rise in price: he expects them to generate constant and increasing cash flow. And he doesn't just hold them for years: he holds them for decades, without selling because of short-term noise. "Would I have to own 28 stocks just to be 'adequately diversified'? That would be nonsense," he asked himself rhetorically.

Now, as always, it's important to put things in context. Buffett doesn't invest like you or me. He doesn't depend on the performance of his portfolio to have a comfortable retirement or to pay his expenses. Berkshire Hathaway is a colossus with internal cash flows that allow it to sustain investments without liquidity pressure. What happens when the market crashes? He doesn't sell: he buys (taking advantage of opportunities and low prices). When a company enters a crisis? He doesn't abandon it: he restructures it or injects capital (although there are always exceptions). His portfolio isn't just a list of companies: it's an ecosystem of interconnected businesses.

So what does this mean for others? Diversification isn't inherently bad, but using it as a reflection of a lack of analysis is a gamble Buffett doesn't recommend. If you can identify and maintain businesses with structural advantages, concentration is viable. If not, diversification is still a tool. But not out of virtue: out of acceptance that not everyone can do the job he can.

In fact, in his own will, Buffett established that 90% of the money intended for his wife should be invested in an ETF that tracks the S&P 500 index, and the remaining 10% in long-term U.S. Treasury bonds. This recommendation is no coincidence: it's a confession that, for those without his analytical skills or time horizon, a concentrated portfolio is unrealistic. Diversification, in this case, is not a virtue, but a tool for those unable or unwilling to dedicate decades to studying business. And while it sounds contradictory, it isn't. Buffett doesn't reject diversification in the abstract: he rejects it when it's used without understanding what one owns. For him, three wonderful companies are enough. For the rest, an index and some stable debt are the best alternative.