How to aim for a million by buying just a few UK shares

Investing in high quality UK shares for the long term is a proven strategy for building wealth. And many people have reached the status of millionaires or even billionaires, thanks to their successful investment portfolios. Of course, investing is not a risk-free endeavor. And, perhaps, one of the most common pieces of advice for novice investors is to diversify your holdings.

However, not everyone is a supporter of diversification and still prefers to maintain a concentrated portfolio. The list includes some of the world’s leading billionaire investors, such as Chamath Palihapitiya and even Warren Buffett.

So why can diversification be bad? And is a concentrated portfolio better?

Diversification vs Concentration

Diversification is a powerful risk mitigation strategy in the investor’s toolkit. But if misused, it can damage the return. Moreover, portfolio concentration paves the way for superior returns, but blindly hoping that some stocks will perform well can be very risky.

For example, suppose an investor has £10,000. After looking at several UK stocks, he decided to invest in just one – Company X. A year later, the investment thesis was a success, with the share price rising by 50% and the investor making an investment profit of £5,000.

But what if he had decided to spread the £10,000 equally across 25 different stocks, including Company X? In that case, a 50% gain would only increase the value of the portfolio by £200. That’s a 2% gain instead of 50%. In other words, diversification reduces the positive impact of successful investments on the portfolio.

However, this also works both ways. What if the investors make a mistake and Company X’s stock price drops 40%? In that case, the loss in a diversified portfolio would be only £160 versus £4,000 in a concentrated one.

So what is the right approach? The answer ultimately depends on individual risk tolerance and stock picking skills. Buffett’s argument against diversification is “no use to anyone who knows what they’re doing”.

The bottom line is that talented investors looking to find high-quality companies should not look for other positions just to diversify. Palihapitiya shares the same opinion that it is better to have 10 fantastic companies than 25 average ones.

Make £1m with top UK stocks

Arguably, the easiest way for novice investors to start building wealth in the stock market is with low-cost index funds. Here in the UK, the FTSE 100 often a popular destination and has historically delivered an average annual return of around 8%. Investing just £500 a month at this rate over 30 years would result in a portfolio worth around £745,000 when starting from scratch.

That is certainly not to be laughed at. But what if the investor chooses to buy only a few of the top UK stocks that return an average of 14% annually? At the same time, the portfolio will be worth £2.75 million, reaching the first million in 23 years.

Needless to say, a hand-picked collection of businesses has the potential to generate very superior profits. But it is important to remember that this is far from guaranteed. And with fewer stocks in a concentrated portfolio to absorb losses, any mistakes can be even more costly.