What is Charlie Munger's criticism of diversification in investing?

Charlie Munger's Core Critique of "Diversification"

Charlie Munger holds a profound and unique critical stance towards the "diversification" investment strategy, often considered sacrosanct in traditional finance. His core viewpoint can be summarized as: Diversification is a protection against ignorance.

Here are Munger's main arguments against diversification:

1. Diversification as Protection Against "Ignorance"

This is Munger's most famous and central argument.

Reasonable for ordinary individuals: He believes that broad diversification is a sensible defensive strategy for investors who lack the understanding or ability to deeply research individual companies. It protects them from catastrophic losses caused by holding a single poor asset.
Wrong for professionals: However, for "professional" investors with the capability and energy to identify and understand exceptional businesses, excessive diversification dilutes the excess returns generated by the best investment opportunities. If you can find an extremely high-conviction opportunity, why allocate capital to your 20th or 50th best idea?

2. "Over-Diversification" Leads to Mediocre Performance

Munger argues that when an investment portfolio holds too many stocks (e.g., 50, 100, or even more), its overall performance will inevitably gravitate towards the market average. After accounting for transaction costs and management fees, it may even underperform the market.

He sometimes refers to this practice as "Diworsification".
For an active investor aiming to outperform the market, holding a large number of stocks almost guarantees mediocre results. You cannot find the needle (the exceptional company) by buying the entire haystack (the market).

3. Advocating Concentration in Few Exceptional Opportunities

Contrary to diversification, Munger is a staunch advocate of "concentrated investing".

Bet Big: He contends that investors should concentrate their capital in a few exceptional companies they deeply understand, possessing durable competitive advantages (i.e., a "moat").
Rare Opportunities: He believes that truly great investment opportunities in one's lifetime are exceedingly rare. When such an opportunity arises, one should bet big. Excessive diversification causes you to miss out on enormous potential gains when faced with an outstanding opportunity because your position size is too small.

4. Limitations of Cognition and Energy

Munger emphasizes that no one can deeply understand a large number of companies simultaneously.

Depth Over Breadth: Attempting to track and research dozens or hundreds of companies inevitably leads to a superficial understanding of each. This shallow knowledge cannot form a genuine investment edge.
Knowledge is the True Margin of Safety: Concentrated investing allows investors to focus their limited energy on a few businesses, thereby gaining a true knowledge advantage. In Munger's view, this deep understanding is the fundamental way to reduce risk, far more important than the number of stocks held.

Distinguishing Applicable Contexts

It's crucial to emphasize that Munger's critique is primarily directed at active investors and fund managers, not ordinary individual investors.

Advice for Ordinary Individuals: For ordinary people lacking the time, interest, or professional ability to conduct deep company analysis, both Munger and Buffett believe that buying low-cost index funds (an extreme form of diversification) is the optimal choice.
Critique of Professionals: His criticism is mainly aimed at the industry phenomenon of fund managers who claim to be stock-picking experts yet hold hundreds of stocks, effectively acting as "closet index fund managers," while charging high management fees.

Summary

In essence, Charlie Munger's critique of diversification is about using the certainty derived from "deep knowledge" to counter the uncertainty brought by "widespread ownership." He believes true investment safety comes not from the number of stocks held, but from the depth of understanding of the assets held. For investors seeking excellence rather than mediocrity, concentrating firepower on a few best ideas is far wiser and more effective than scattering bets aimlessly.