Buffett Beyond Value: Why Warren Buffett Looks to Growth and Management When Investing

Chapter 16. Diversification: How Many Baskets Should You Hold?

Don't put all your eggs in one basket.

—Proverb

But how many baskets should you hold? Diversification is one of the most talked about investment concepts. The concept is simple: "Don't put all your eggs in one basket." Perhaps a more interesting question is, "How many baskets should you possess, and how do you decide the number of eggs to be placed in different baskets?" We use the basics of diversification all the time throughout our day-to-day lives. When we travel, we usually pack a variety of clothing suited to different weather conditions because we cannot predict the weather perfectly. We learn to speak different languages so we can communicate with others who do not speak our own language. We acquire a variety of skills to prepare ourselves to earn a living. A person with a diverse knowledge base finds it easier to deal with the unavoidable ups and downs of life.

A diverse knowledge base enhances our understanding of others' viewpoints and helps us make better decisions. The more different things we have in our repertoires, the more prepared we are for the unexpected. Thus, we diversify to protect ourselves from uncertainties and unpleasant situations. You should do the same to protect your wealth.

Diversification

Consider a company that owns two stores, one that sells expensive clothes and one that sells discounted merchandise. Profit margins are usually higher for expensive clothes. When the economy is doing well, ...