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Your Portfolio Style: Concentrated or Diversified?


Talented investors can reap rewards with both.

Back on August 21st, I authored an article entitled What's Your Core Investment Style?, in which I compared the market-timing aspects of various investing styles.

I now want to take the portfolio-strategy discussion to the next level, by talking about portfolio composition.

Successful investors follow one of two portfolio construction styles. They either concentrate their holdings into a handful of issues, or they diversify, tilting the positions from an economic sector and/or style perspective. Let's look at the pros and cons of each.

Concentrated-Portfolio Approach

The most celebrated investor following this approach is, of course, Warren Buffett. Using a value-oriented methodology, Mr. Buffett constructs his portfolios with large bets in a modest number of issues.

The pros: Big bets lead to big gains. The cons are obviously the converse: Big bets can lead to big losses. There's also the risk of underperformance when market action takes place away from the areas where the big bets are made, as it did with Buffet's bets in value-oriented investments during the tech bubble. Lastly, there's the less-obvious disadvantage of the portfolio's volatility.

Stocks are more volatile than industries, which are more volatile than economic sectors, which are more volatile than the market overall. Therefore, it stands to reason that a concentrated mix of issues -- if they aren't a fully-diversified mix of investments -- will produce a more volatile portfolio experience.

Diversification Approach, with Sector and/or Style Tilt

This approach reduces the volatility factor. It does so by spreading the portfolio money into each of the 10 S&P economic sectors: Consumer discretionary, consumer staples, energy, financials, healthcare, basic materials, information technology, telecommunication services, industrials and utilities.

One may also spread one's portfolio among the 6 investment styles: large-cap growth, large-cap value, mid-cap growth, mid-cap value, small-cap growth and small-cap value.

Reduced volatility leads to more consistent results. However, the converse of this approach is the mirror image of the concentrated-portfolio approach: There are no large bets; therefore, no large gains or losses (above the market) are possible.
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No positions in stocks taken.
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