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YOU MAY BE FAMILIAR with Peter Lynch. In the 1970s and ‘80s, he was one of the most visible figures in the investment world. As manager of Fidelity Magellan Fund, he achieved the best track record, by far, among his peers. He shared his wisdom in a series of popular books for individual investors.
Among the ideas for which Lynch is best known is the notion of “diworsification.” As its name suggests, Lynch argued that diversification simply for the sake of diversification isn’t always a good thing. If a portfolio is diversified in ways that detract from performance, it ends up being counterproductive.
This argument poses a challenge for individual investors. Especially this year, amid a rocky stock market, diversifying seems like the right thing to do, and that’s a broadly held view. Diversification is often referred to as the first rule of investing. So why do Lynch and others disagree, and what’s the best approach for individual investors?
The arguments for diversification are straightforward. Because investments rarely move in lockstep with each other, it’s helpful to have a mix of holdings. If share prices don’t all move up and down together, having a mix of stocks—especially in combination with a mix of bonds—can help dampen a portfolio’s price swings. Because of this dynamic, it’s almost a truism of personal finance that diversification simply makes sense.
This view has been broadly accepted in finance at least since the 1950s, when Harry Markowitz wrote his Ph.D. thesis on the topic. Markowitz’s paper is full of detailed formulas. But even before Markowitz, the intuition behind diversification was well understood. King Solomon offered this advice: “Invest in seven ventures or eight; you do not know what disaster may come.” Similarly, there’s the popular aphorism “don’t put all your eggs in one basket.”
But not everyone shares this view. In 1885, industrialist Andrew Carnegie gave a commencement address at a local college, and here’s what he said: “Don’t put all your eggs in one basket is all wrong.” He criticized those who scattered their investments “in this, or that, or the other, here, there and everywhere.” Scattered efforts, he felt, led to scattered results. Instead, Carnegie advised the audience, “Put all your eggs in one basket, then watch that basket very carefully.” In other speeches, Carnegie echoed this theme. “The great successes in life,” he said, “are made by concentration.”
Over the years, numerous investors have seized on this philosophy. Hedge fund manager Stanley Druckenmiller has cited this as his guiding principle. “All the great investors have made their fortunes by doing the opposite of diversifying,” he’s said, citing Warren Buffett and other fellow fund managers. According to Druckenmiller, Carl Icahn once put half his net worth into one stock—Apple—and made a fortune.
Warren Buffett has been maybe the most vocal proponent of this approach. “Diversification is a protection against ignorance. It makes very little sense for those who know what they’re doing.”
How can investors reconcile these viewpoints? On the one hand, diversification seems like the right thing to do, supported by both intuition and by decades of research. And yet some of the world’s greatest investors dismiss it with disdain.
The answer, I believe, is hiding in the details. Buffett says that diversification makes no sense, but he qualified that by adding “for those who know what they’re doing.” Similarly, Buffett’s late partner, Charlie Munger, once said, “The idea that a big portfolio of stocks is safer than a concentrated one is madness,” but added “assuming you know what you’re doing.”
In other words, holding an undiversified portfolio might make sense, but only if it’s your full-time job—that is, if you have the time to “watch that basket very carefully.” For ordinary people, Buffett and others agree that diversification makes good sense.
In fact, the reality is that even the greatest investors don’t always get it right. For years, Wells Fargo was one of Berkshire Hathaway’s largest holdings. But when a pattern of fraud came to light, the stock cratered, and Berkshire ultimately exited the investment. Stock-picking isn’t easy, even for these pros.
Risk of loss is one reason to avoid being too concentrated. But academic research has identified another reason to embrace diversification. As I’ve noted before, research by academic Hendrik Bessembinder has found, counterintuitively, that just a tiny fraction of stocks—4%—account for all of the stock market’s net gains relative to Treasury bills. The implication: If a portfolio isn’t sufficiently diversified, it runs the risk of excluding the next Apple or Nvidia, and that could be costly.
What does it mean to build a sufficiently diversified portfolio? For starters, it should be diversified along more than one dimension. Nearly every investor, in my view, should own a combination of stocks and bonds. In addition, holding cash can help carry a portfolio through years like 2022, when both stocks and bonds were down. Next, look to diversify within bonds and within stocks.
The market this year, in fact, has delivered a picture-perfect example of why diversification matters. For the past 15 years, investors have been punished for choosing virtually anything other than the S&P 500. But this year we’ve seen that reverse. International markets have outperformed. Meanwhile, within the U.S., value stocks have outperformed growth stocks like the “Magnificent Seven” that have led the market for years. Diversification, in short, can test investors’ patience. But as we’ve seen recently, it can pay off when we least expect it.
A note of caution: While diversification is important, it’s also important to diversify sensibly. In 401(k) plans, researchers have found that plan participants sometimes choose investments in ways that only look diversified. One study, for example, found that investors used a “1/N” approach to allocating their 401(k) funds, putting an equal amount into each fund regardless of fund type. Another study found that 401(k) participants exhibited “alphabeticity” bias. They diversified but tended to pick from the top of the list.
How can you avoid these pitfalls? A rule of thumb I suggest: Select investments in a way that covers all of the world’s major stock markets but with as little overlap as possible. For bonds, where exchange rate fluctuations can easily offset any gains, I recommend that investors stay closer to home. A sensible mix of domestic bonds, in my view, is perfectly sufficient.
Also keep in mind that diversification isn’t just about portfolio management. Several years ago, I suggested five other ways to diversify, and there are likely many more. It is, I believe, the golden rule of personal finance.
Adam M. Grossman is the founder of Mayport, a fixed-fee wealth management firm. Sign up for Adam’s Daily Ideas email, follow him on X @AdamMGrossman and check out his earlier articles.
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It seems to me the point of diversification is to avoid concentration. Easy examples of concentration are the employee who never sells his company stock grants and the business owner who never takes money out of the business.
I say this because playing multiple games (stocks, bonds, foreign, domestic, real estate, crypto, precious metals) is more of a game for fund advisors or institutional investors in my mind. This is way past concentration, and sufficient diversification was likely achieved in most dimensions far sooner that that.
Rather I would say that an S&P 500 fund is mildly concentrated because the biggest companies are over 5%. Owning one other fund of almost any kind except a market capitalization weighted fund in a proportion as low as 25% will solve this problem. Anything more is more than sufficient diversification.
So taking Adam’s thought about many kinds of diversification I would ask, do I have one or more areas of concentration? If so, what can I do to reduce that or balance it with something else [that is also good, but not perfect.]
My own biggest area of concentration is quite obvious–Colorado Springs real estate. It’s not having 4% of the remaining investment portfolio in some multi-national corporation with offices around the world.
The vast majority of writing on diversification suffers from lack of distinctions.
1) Institutional vs individual investing
Markowitz’s Modern Portfolio Theory (MPT) applies primarily to institutional investing. It has vastly less application to individual investing. Markowitz himself admitted he doesn’t follow it for his personal investments. Why do you think Lynch, Buffett, and many others say that individual investors have advantages over institutions? The answers are obvious, and have been stated over and over. Nonetheless the financial advisory industrial complex fails to observe the basic differences between institutional and individual and we ask the “diversify or not” question over and over mindlessly.
2) Concentration isn’t “stock picking”
Stock picking is buying and selling individual stocks repeatedly. Individuals or institutions can do it. But individuals who buy a company (stock) and hold it for decades, “like a farm” as Buffett says, aren’t stock picking. This used to be called “coffee can investing” where a stock note was stored away for the LT.
When you adjust for such critical distinctions in basic concepts and terms so as to match reality, you’ll find there is no contradiction in the fact that “some of the world’s greatest investors dismiss [diversification] with disdain”. Nor will it be surprising that the diversification –the primary tenet of MPT– isn’t in fact “the golden rule of personal finance” without qualification.
Lynch and Buffet don’t dismiss MPT, they just realize that MPT certainly does not apply to all investing. In fact it is extremely difficult to know under what circumstances MPT actually does apply to reality.
So there is no contradiction or mystery in all this. You’re welcome.
Lynch was the investment guru of the 80s. I read a couple of his books. He always presented common sense ideas for investing that anyone could follow. However, he had a stable of financial analysts who augment those common sense ideas which I did not have.
He was phenomenally successful and I was sorry to see him retire.
Words to live – and invest – by.
Trying to beat the market; trying to pick the next hot stock; trying to do anything other than stay with the market – is hog behavior.
Be piggy. Relax and sleep well. All will be fine.
Right. I mean it’s not as if selling winners and too much buying and selling is the primary reason for poor returns. /sarc “Nobody ever lost money taking a profit” or something like that? If only. People make large bets on inflation staying low over their lifetimes and claim we’ll all sleep so well at night if we just do the same.
Is a falling US dollar good for international stock index funds?
Yes, if the U.S. dollar falls, it boosts the value of foreign stocks for U.S. holders.
Doesn’t that depend on whether the fund is hedged?
If a fund hedges its currency exposure — few stock funds do, but some bond funds hedge — shareholders get no benefit from a weaker dollar.
I own one of the few – Tweedy Browne International Value, TBGVX. I wouldn’t buy it today, but it’s in taxable and I don’t want to increase my income by selling it. Thanks to RMDs I’m already on the second IRMAA rung.
I do think the real purpose of diversification is to achieve a portfolio that does well over long periods of time. The definition of “does well” is subject to my goals and varies from person to person. I am a “buy and hold, but not forever” investor. I don’t pay much attention to the peaks and valleys. Of more value to me is the long-term trend line.
Using diversification reduces my exposure to any single asset class. There are benefits but I can expect to lag the best performing asset class each year. In recent years the performance of a diversified portfolio such as mine did not match the performance of the highflyers. A comparison to the remarkable run-up of the S&P 500 and the NASDAQ 100 in recent years emphasizes that.
I do like using the Callan Periodic Table of Investment Returns as a visual aid. It depicts 20 recent years of annual performance for 9 differing asset classes. It’s available at the website and recent and older tables are also available by browsing for images of it.
My definition of “doing well” for my portfolio is actually in a range. At the bottom of that scale is the value of inflation. At the top is the S&P 500 and the Nasdaq 100.
Per Callan’s table 2023 was a remarkable year with all classes doing well. The worst performer in 2023 was cash at 5.01%!
Looking deeper in the most recent 20 year period cash and fixed income were the best performers for 4 years as well as the worst performer for 8 years.
During that same period Large Cap Equity was the best performer for 6 years and the worst in none of those years.
2015, 2018 and 2022 were the worst performing years and during those years even the best performing asset classes returned less than 2.0%.
As a part of my diversification, I do own individual stocks and bonds. That may seem to be counter intuitive. The returns are expected to deviate from the indexes and have. Certain stocks have done better than their asset class but picking them can be challenging and outcomes are not guaranteed. Owning individual bonds can avoid upsets as occurred in 2021.
I do own some shares of individual stocks but there is some work required. My best performers since 2008 have been individual stocks. I have one loser, currently down 15.64%, it was purchased in 2024. At the other end of the scale is one stock with a gain of 688% since 2008.
Speaking of Warren Buffett, his famous quote “only when the tide goes out do you see who’s been swimming naked” certainly applies to these times. Which is to say, for individual investors, this is when you find out what your actual, rather than hypothetical, risk tolerance actually is.
At times like these (or better yet, before experiencing times like these), especially for retirees, It can be instructive to look at which kinds of portfolios have performed well during the very worst markets. There are lessons about diversification to be learned that go well beyond holding buckets of stock index funds, U.S. bonds and cash.
https://portfoliocharts.com/2025/04/09/how-to-succeed-in-the-worst-stock-markets/
Nice article, Adam. Thank you!
Peter Lynch managed money for a very short time & his style – buy what you know fit the time – consumer stocks were in vogue. In the short run it is impossible to distinguish luck from skill and even WB has been mean reverting over the last two decades. Diversification is a free lunch. A concentrated portfolio is gambling & over the short run gambling can be successful.
“Diversification is a free lunch.”
There are none. Declaring it so doesn’t make it so. “Risk-adjusted” is the term that makes the “diversification is an almost free lunch” declaration of MPT true *by definition* (according to the formula). When people who see data that doesn’t fit the narrative, they cry “lucky bastard!”. It’s an old game, but so many never catch on.
I know that many will say that my post is poorly timed , since international stocks have outperformed US of late. I have used Portfolio Visualizer to compare US versus International over 10, 20, 30 and 40 year time periods; and have found that International is a drag on results. Seems like Buffett, Bogle and Scott Burns have been correct that a S&P 500 index or Total Market Index, along with a Total Bond Market Index provided diversification and long-term performance.
Some of the experts are predicting that international stocks will do better this year. But since 2018 the developed market ex-US equity class annual returns have ranged from -14.09% to 17.94%. Emerging market equity has ranged from -14.57% to 18.44%. Over the same period US large cap equity has ranged from -18.11% to 31.49%. What this means to me is holding some foreign stock is probably prudent in a diversified portfolio. But I won’t be chasing this. My portfolio has been 12% foreign stocks and my spouse’s 13%. We won’t be changing this allocation.
I think the to decision diversify is a function of your desired outcomes and investing goals. If you are looking for pure growth then picking a small number of potential winners makes sense. But if you are looking for capital appreciation and preservation, broad diversification is the better choice. Just like the game of craps…you can either put all your chips on a few numbers and win big, or you can spread your bets and stay at the table longer.
The optimal concentration outcome has always been born out when a stock is owned for decades and risk goes down as the company matures. It is optimal of course, and comparatively few will get this outcome. Still, a surprising number do. There have been millions of multimillionaires minted by simply owning IBM, MSFT, or Apple and never selling.
IBM IMO has been disfunctional and not a new place for money for decades, but families who inherited it did not lose principle. Contrary to the warnings of the usual suspects, IBM stock didn’t go down when it fell off the top 10 market cap chart. That’s not the way it works.
Many have piled into these companies over the years and reaped the growth and then the stability that followed as they matured. I’m by no means suggesting this as a strategy. But let’s not deny the reality that many saw that “silicon is the new oil”, bought what they knew and placed their bets, and as it happened attained generational wealth. Chasing profits is one thing, but denying reality is another.
To me the differences between a casino, where the house has the odds, and the market where time is on your side are immense.
Sure, but in the difference between the casino and “the market” you set up, that market isn’t necessarily an index. It has been truly said that “it isn’t a stock market, but a market of stocks.” When you say “the market” you could mean either one.
Or you can put all your chips on a few numbers and lose big. I know which I think is more likely.
See what happened when a fund formed in 1935 with 30 stocks of the era and didn’t add or sell to this very day.
Look up the story of the Voya fund on Morningstar piece “The Strange and Happy Tale of Voya Corporate Leaders Trust”. I don’t think we take seriously enough Buffett’s view, that –in my paraphrase– is basically that investing is primarily a geopolitical bet, whether we realize it or not.
https://www.morningstar.com/columns/rekenthaler-report/strange-happy-tale-voya-corporate-leaders-trust
I based my system loosely on 3 Buffet’s rules but adapted it to funds: Rule No. 1: Never Lose Money. Rule No. 2: Never Forget Rule No. 1 and Rule 3: Diversification is a protection against ignorance. I added a fourth rule: momentum. I also liked Bogle’s ideas of owning just 2-3 funds but changed it to 5 funds. My system was born in early 2000. I didn’t want to own stocks, so I used funds.
Basically: my generic system looks for the best 5 wide range funds with good risk-adjusted performance, keeps changing them using momentum, and each fund must perform well. You do that 2-3 times annually. The idea is to be mostly in the right category + achieve better risk-adjusted performance by looking at performance first and then selecting the best SD + Sharpe ratio funds. In 2017, I changed it from owning 5 funds to just 2-3 funds, back to Bogle’s idea. BTW, Buffett said many times that most investors should use just one fund, the SP500, again, concentration and not over-diversification.
The above led me to invest as follow
1995-2000: Mostly SP500 + SP500 growth
2000-2010: Mostly US Value+small cap and some International
2010-2017: Mostly US large-cap tilting growth.
2017: One year prior to retirement, invested mostly in bond OEFs since then and timing markets. Timing is another subject that isn’t supposed to work, but it did great for me. That’s because my portfolio is big. I don’t care much about performance; I just want to beat 50/50 portfolios, but I never want to lose more than 3% and…I have done that.
“Diversification is a protection against ignorance”. This sentence accurately forms the basis for my investments. I just don’t know what I don’t know about investing, so I use tools like Morningstar X-Ray to help.