John Maynard Keynes
Own what you understand
Spread too thin, you have only spread your ignorance evenly
Letter to F. C. Scott, August 1934
I own a little of everything and understand none of it. This page asks whether spreading out cuts risk, or only hides what you don't know.
What actually happened?
In August 1934 Keynes, by then managing money for a Cambridge college and for insurance companies, wrote to a colleague about how to invest. He had come to think the usual advice ran backwards. "It is a mistake to think that one limits one's risk by spreading too much between enterprises about which one knows little and has no reason for special confidence." The right method, he said, was to put fairly large sums into businesses one thinks one knows something about, and whose management one thoroughly believes in.
More names is not less risk
Scatter money across many companies you cannot judge and the risk has not shrunk. You merely cannot explain any single holding. The risk is still there, hidden in every position at once.
Ten funds sit in the account, and you couldn't say what any one of them actually owns.
Understanding and trust, both
The concentration he wanted was narrow: places where you truly grasp the business and truly trust the people running it. He added that at any one time there were seldom more than two or three such enterprises for him.
Before adding to a holding, can you say how it earns, and why its managers deserve trust? If not, it is not on the list.
Ask whether you can explain it
He did not say to own only one or two names. He said not to use numbers to make up for understanding. What you can explain in a few sentences deserves a larger position; what you cannot is just ignorance, spread evenly.
Half the money in the two firms you really know, half plainly in an index fund, is clearer than a dozen you half understand.
How do I use it today?
Where you are: You own a little of everything, and when you open the account you cannot say why each thing is there.
Ask first: Which holdings can I explain in three sentences, how it earns and why its managers are trustworthy? For the rest, is that a position I knowingly keep as "I don't know", or did I just buy it to be done?
Where it goes wrong: Reading it as "put everything in one place." He said not to let a count stand in for understanding. He never said not to diversify.
Lines to keep
Spread as wide as you like, you can't spread out what you don't know.
Owning many is not seeing clearly.
If you can't explain it, don't size it big.
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