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growth in purchasing power of 0%. That is not good.

In a world of 5% inflation we need a return in excess of 5% to show a real growth in purchasing power. And in a world of 10% inflation we would need a return in excess of
10%.
THE EFFECTS OF TAXATION
Taxation adds another perspective to the situation. If we manage to obtain a 5% return on our money, income taxes can take 31% of that 5%, which means that we will be left
with a real return of 3.45%. This means that in a world of 5% inflation, after paying income tax, we will be experiencing a real loss of purchasing power of 1.55% a year, also
not good.
So in a world with 5% inflation and 31% income tax, we need an annual return on our investment of at least 7.2% just to stay even in the game and not have the purchasing
power of our wealth diminish.
This means that if you want to increase your wealth, you must have an annual return in excess of 7.2%. If you invest in corporate bonds that pay an 8% return on your money,
then, in effect, the return on your investment is less personal income tax approximately 31% (depending on which income tax bracket you fall in), which means you end
up with an after-tax return of 5.5%. Subtract a 5% rate of inflation, and your real rate of return goes to 0.5%.
If you increased the rate of inflation to 9% and the tax rate to 40%, a situation we had in the early seventies, you must have a return of at least 15% for the real purchasing
power of your wealth to stay intact (15% 40% tax rate = 9%; 9% 9% rate of inflation = 0%).
During the last twenty years in American history, we have seen double-digit inflation and tax rates of 50% and higher on personal income. Warren has come to believe that
politicians will constantly try to inflate the economy and at the same time raise taxes. So he set up the minimum possible pretax annual compounding rate of return he wanted
to achieve on his investments approximately 15%.
It is interesting to note that Graham felt that the "long-term trend is toward inflation, punctuated by equally troublesome periods of deflation," and, "common stocks are by no
means an ideal protection or 'hedge' against inflation, but they do more for the investor on this point than either bonds or cash" (Security Analysis, 1951, p. 8).
So, in summary, if you desire to have a real increase in your purchasing power, then it is necessary that the return on your wealth be at least equal to the effects of inflation
and taxation.

26
The Myth of Diversifications Versus the Concentrated Portfolio
Warren believes that diversification is something people do to protect themselves from their own stupidity. They lack the intelligence and expertise to make large investments
in just a few businesses, so they must hedge against the folly of ignorance by having their capital spread out among many different investments.
As we know, Graham's investment strategy required that he have literally one hundred or more stocks in his portfolio. He did this to hedge against the possibility that some of
his investments would never perform, as businesses and as stocks. The nature of the business, he felt, was locked into the numbers, and he was not all that concerned with
really getting to know the businesses he owned.
Warren followed Graham's strategy for a while but in the end found that it was more like owning a zoo than a stock portfolio. And as he shifted his method of analysis to the
Munger/Fisher format, he found that he had to have a better understanding of the businesses he was investing in than Graham did.
Fisher, though agreeing that some diversification was necessary, thought that diversification as an investment principal was way oversold. (He pointed out that some cynics
thought this was because it was a simple enough theory for even stockbrokers to understand.) Fisher agreed that investors, responding to the horrors of putting all their eggs
into one basket, ended up spreading out their eggs into dozens of different baskets, with many of the baskets ending up containing broken eggs. Also, it was impossible to
keep an eye on all the eggs in all the baskets. Fisher thought that most investors had been so oversold on diversification that they ended up owning so many stocks that they
had little or no idea of what kind of businesses they had invested in.
Warren was greatly influenced by the writings of the late, great British economist John Maynard Keynes. Keynes, a person of noted expertise in the field of investments, said
he had made the majority of his money in just a few different investments the underlying businesses whose investment value he understood.
Warren has adopted the concentrated-portfolio approach, which means that he holds a small number of investments he really understands and intends holding for a long
period of time. This allows the question of whether to allocate capital to an investment to be approached with the utmost seriousness. Warren believes that it is the seriousness
with which he addresses the questions of what to invest in and at what price that decreases the risk. It is his commitment to the strategy of investing only in exceptional
businesses at prices that make business sense that reduces his chances for loss.
Warren has often said that a person would make fewer bad investment decisions if he were limited to making just ten in his lifetime. Just ten. You would put a little work into
making those ten decisions, don't you think?
It's amazing that intelligent, hardworking individuals think nothing of taking a large portion of their net worth and investing it in a company they know little or nothing about.
If you ask them to invest in a local business, they would pepper you with questions. But let some stockbroker call them on the phone, and the next thing you know, they are
partial owners of some exotic business.
Baruch said: "Time and energy are required to keep abreast of the forces that may change the value of a security. While one can know all there is to know about a few issues,
one cannot possibly know all one needs to know about a great many issues" (My Own Story, Holt, Rinehart & Winston, 1957).
Baruch, by the way, lived to be a very old and a very, very wealthy man.

27
When Should You Sell Your Investments?
The investment business is said to be 50% science and 50% art and 100% folklore. The Wall Street folklore that surrounds selling has something to do with the old adage that
no one ever went broke by selling at a profit. Warren might respond that no ever got really wealthy that way either. (That last sentence should have caused a big question mark
to appear in your head. Curious? Let us see why Warren thinks that this old adage won't make you superrich.) Please note: Parts of this chapter appear in other sections of the

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