"Put all your eggs in our basket and watch that basket." - Mark Twain.

The debate over what constitutes adequate diversification has been ongoing for hundreds of years. Today, the conventional wisdom among both practitioners and academics is that the Italian proverb was more on target than was Mark Twain.

A recent article in "Forbes" magazine states that of the over 6000 mutual funds currently in operation, only eight own 20 or fewer stocks, and the average fund owns 120 issues. Diversification has become like wealth and weight loss: the very concepts of too rich, too thin and too diversified are viewed as nonsensical.

Twenty-five years ago, the academic community began to quantify the risk reduction achieved when the number of stocks in a portfolio is increase. MBA and CFA candidates still study the graph of portfolio risk versus the number of randomly selected securities in a portfolio. As the number of stocks in a portfolio increases, the portfolio risk decreases approaching the market risk level.

To the efficient markets fan, the most interesting point of this presentation is that adding additional stocks to the portfolio always reduces risk. To the individual who believes that good investors can identify superior stocks, the most interesting point is that a five- to ten-stock portfolio eliminates 80-90% of the non-market risk of an individual stock.

Nonetheless, many investment managers who consider themselves stock pickers still run 100-stock portfolios. On top of that, most investors allocate their assets among more than one equity fund. The result of this over-diversification is that investors pay high fees to achieve market performance. At least an index fund charges a low fee to get the same result.

Undoubtedly, today's most accomplished concentrated investor is Warren Buffett, whose investment results and clarity of thought we greatly admire. In closing, consider a quote from Berkshire Hathaway's 1991 Annual Report about an investor Buffett admired:

"John Maynard Keynes, whose brilliance as a practicing investor matched his brilliance in thought, wrote a letter to a business associate, F. C. Scott, on August 15, 1934, that says it all: 'As time goes on, I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. 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...'"