Putting all my eggs in only a few baskets
Apr 27, 2014 6:58:42 GMT 7
candy188, stevenlsf, and 2 more like this
Post by oldman on Apr 27, 2014 6:58:42 GMT 7
There is a an article written in Sunday Times today with reference to this chapter in my book. The article is entitled: To diversify or not - that is the question.
A book published in 2009 by Dr Michael Leong, founder of investment portal ShareInvestor, speaks out against diversification, or excessive diversification.
"For all my long-term investments, I only have about five stocks," says Dr Leong in Your First Million: Making It In Stocks. "If I diversify too much, even if a stock rises 100 per cent, it may not increase the worth of my portfolio significantly."
Investors feel good when one stock rises strongly but their portfolio value does not increase by much if they have spread their investments too thin.
"My aim in investing is to multiply my net worth and not to feel good," he says. "If I want to feel good, I will drink my gin and tonic."
Read the full Sunday Times article here: www.cpf.gov.sg/imsavvy/rss_feed.asp?t=hdl-20101
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Your First Million, 2nd Edition
Chapter 4: Putting all my eggs in only a few baskets
For my long-term investments, I only have about five stocks. My rationale is simple. If I diversify too much, even if a stock rises 100%, it may not increase the worth of my portfolio significantly. Of course, it is nice to feel that you have a one bagger. But what good is this if you only feel good and your portfolio worth only increases marginally? My aim in investing is to multiply my net worth and not to feel good. If I want to feel good, I will drink my gin and tonic.
Good thing about investing is that you have only one mission, which is simply to make your money grow as fast you can. For stocks that represent a significant part of my portfolio value, you can bet that I watch it like a hawk. I look out for announcements on the company and try to understand as much as I can about the industries in which it operates. But you can devote such intense focus only on a handful of stocks without wearing yourself out.
By nature, we are all risk adverse, so when we invest, the natural tendency is to spread our risk all over the place. Sadly, many so-called professionals recommend this spreading of risk approach to their clients. Like what investment guru Warren Buffett said, “Wide diversification is only required when investors do not understand what they are doing.” Hence, an investor must first of all be a master of fundamental investing, especially the concept of margin of safety, before he goes into focused investing. Otherwise, focused investing can be a recipe for disaster.
If I want to invest properly in the stock market, I must be willing to take risks. I reduce my risk by understanding thoroughly the companies that I invest in. I understand their industries and keep myself updated on what is happening worldwide. I do not reduce my risk by spreading my investments as thinly as I would spread butter on a toast.
Another analogy is that of your spouse. You have only one spouse. It was a tough decision when you signed on the dotted line. You are now fully committed and will take care of your only family. It is because we have only one spouse, one family and one job that we can push ourselves to become the best we can be as a spouse, parent and as a professional. If we have a number of families and jobs to juggle, our attention would have been scattered.
In stocks, we are in a way allowed to be polygamous and we all know the problems of this. We should be happy already that we could have more than one stock! Five is already a handful – any more is a crowd that is really impossible to handle!
I have come across many investors who have more than 30 stocks in their portfolios. When I ask them why they have so many stocks, they all tell me the same thing, which is that they are not sure which stocks will run up. Hence, having 30 stocks will give them a higher chance of ‘getting it right’ than having just a handful of stocks.
By the law of probabilities, they are absolutely right. They stand a much higher chance of getting multi-baggers than I would. They can then either sell these stocks when they double and plough the money into the rest of their stocks or they can hold on to their multi-baggers. If they held on to their multi-baggers, even though these may zoom up substantially in value, their total portfolio may not have increased that much, as the percentage of their portfolio in this ‘winner’ is relatively low.
If they sold when these shares double and put the winnings into the rest of their other stocks, they are then hoping that the other stocks will each also become multi-baggers. This theory sounds good but in reality, it is quite difficult to get one multi-bagger after another. More than likely, in a portfolio of 30 stocks, there will be performers as well as losers.
Yes, I too adopted these strategies in my earlier investing life. I certainly had my multi-baggers before, but as these do not represent a significant percentage of my total portfolio, the effect of the multi-baggers on my total net worth was not that substantial. Hence, though I felt good, contrary to what I had thought, my pocket was really not that much better off. One of the reasons I did not do as well was because I had ‘lemons’ among my other stocks. In other words, some of the stocks performed very well, while others did badly.
Nowadays, I am a much more focused investor with just five key fundamental stocks, as I believe that when one invests, one should invest a meaningful amount. As we age and accumulate wealth, what is considered a meaningful investment increases in value all the time. We simply have to learn to live with the size of our investments in each of these companies, rather than spread them too thinly across many companies.
That said, as my portfolio increases in value, I do have other stocks that I am also slowly collecting as well. However, my five fundamental stocks still represent the bulk of my investments.
The key to financial freedom is to invest till it hurts. If one speculates with only 10% of one’s funds, this really will not hurt. Even if it goes up 10 times, it is not going to make you very wealthy, as you have to start afresh with another speculation. As you continue speculating, the amount that you speculate increases. Then one day, Lady Luck may not smile at you anymore and you can lose everything you have built up.
If you speculate the market with 100% of your net worth, then you are really a very big risk taker and I really wish you the Best of Luck! For me, the only way I am willing to invest a significant percentage of my net worth is to invest in fundamentally sound stocks. To make each investment meaningful, I only hold a handful of stocks. As a collapse in any of these stocks can be very painful financially, I take my time to know the stocks well and then monitor them carefully after that.
Like it or not, there is no gain without risk. If you seek financial freedom, you have to put to risk a large chunk of your capital. To reduce the risk on this capital, you have to do your homework and believe in yourself and your selection of stocks. I have found this to be the least risky way of growing my capital.
Of course, if you are a multi-millionaire, you may think differently, as you would want to find ways of preserving your wealth and diversification under such circumstances would make some sense. But for those who are just starting out to build up their wealth, a focused investment strategy is more likely to give much better returns.
However, to be able to do this successfully, you must spend quality time understanding not only the companies that you invest in but also the mechanics of the stock market. There is no shortcut to financial freedom. If you don’t spend enough time understanding the markets or the companies that you invest in, it is unlikely that you can become a successful investor.
A book published in 2009 by Dr Michael Leong, founder of investment portal ShareInvestor, speaks out against diversification, or excessive diversification.
"For all my long-term investments, I only have about five stocks," says Dr Leong in Your First Million: Making It In Stocks. "If I diversify too much, even if a stock rises 100 per cent, it may not increase the worth of my portfolio significantly."
Investors feel good when one stock rises strongly but their portfolio value does not increase by much if they have spread their investments too thin.
"My aim in investing is to multiply my net worth and not to feel good," he says. "If I want to feel good, I will drink my gin and tonic."
Read the full Sunday Times article here: www.cpf.gov.sg/imsavvy/rss_feed.asp?t=hdl-20101
-----------
Your First Million, 2nd Edition
Chapter 4: Putting all my eggs in only a few baskets
For my long-term investments, I only have about five stocks. My rationale is simple. If I diversify too much, even if a stock rises 100%, it may not increase the worth of my portfolio significantly. Of course, it is nice to feel that you have a one bagger. But what good is this if you only feel good and your portfolio worth only increases marginally? My aim in investing is to multiply my net worth and not to feel good. If I want to feel good, I will drink my gin and tonic.
Good thing about investing is that you have only one mission, which is simply to make your money grow as fast you can. For stocks that represent a significant part of my portfolio value, you can bet that I watch it like a hawk. I look out for announcements on the company and try to understand as much as I can about the industries in which it operates. But you can devote such intense focus only on a handful of stocks without wearing yourself out.
By nature, we are all risk adverse, so when we invest, the natural tendency is to spread our risk all over the place. Sadly, many so-called professionals recommend this spreading of risk approach to their clients. Like what investment guru Warren Buffett said, “Wide diversification is only required when investors do not understand what they are doing.” Hence, an investor must first of all be a master of fundamental investing, especially the concept of margin of safety, before he goes into focused investing. Otherwise, focused investing can be a recipe for disaster.
If I want to invest properly in the stock market, I must be willing to take risks. I reduce my risk by understanding thoroughly the companies that I invest in. I understand their industries and keep myself updated on what is happening worldwide. I do not reduce my risk by spreading my investments as thinly as I would spread butter on a toast.
Another analogy is that of your spouse. You have only one spouse. It was a tough decision when you signed on the dotted line. You are now fully committed and will take care of your only family. It is because we have only one spouse, one family and one job that we can push ourselves to become the best we can be as a spouse, parent and as a professional. If we have a number of families and jobs to juggle, our attention would have been scattered.
In stocks, we are in a way allowed to be polygamous and we all know the problems of this. We should be happy already that we could have more than one stock! Five is already a handful – any more is a crowd that is really impossible to handle!
I have come across many investors who have more than 30 stocks in their portfolios. When I ask them why they have so many stocks, they all tell me the same thing, which is that they are not sure which stocks will run up. Hence, having 30 stocks will give them a higher chance of ‘getting it right’ than having just a handful of stocks.
By the law of probabilities, they are absolutely right. They stand a much higher chance of getting multi-baggers than I would. They can then either sell these stocks when they double and plough the money into the rest of their stocks or they can hold on to their multi-baggers. If they held on to their multi-baggers, even though these may zoom up substantially in value, their total portfolio may not have increased that much, as the percentage of their portfolio in this ‘winner’ is relatively low.
If they sold when these shares double and put the winnings into the rest of their other stocks, they are then hoping that the other stocks will each also become multi-baggers. This theory sounds good but in reality, it is quite difficult to get one multi-bagger after another. More than likely, in a portfolio of 30 stocks, there will be performers as well as losers.
Yes, I too adopted these strategies in my earlier investing life. I certainly had my multi-baggers before, but as these do not represent a significant percentage of my total portfolio, the effect of the multi-baggers on my total net worth was not that substantial. Hence, though I felt good, contrary to what I had thought, my pocket was really not that much better off. One of the reasons I did not do as well was because I had ‘lemons’ among my other stocks. In other words, some of the stocks performed very well, while others did badly.
Nowadays, I am a much more focused investor with just five key fundamental stocks, as I believe that when one invests, one should invest a meaningful amount. As we age and accumulate wealth, what is considered a meaningful investment increases in value all the time. We simply have to learn to live with the size of our investments in each of these companies, rather than spread them too thinly across many companies.
That said, as my portfolio increases in value, I do have other stocks that I am also slowly collecting as well. However, my five fundamental stocks still represent the bulk of my investments.
The key to financial freedom is to invest till it hurts. If one speculates with only 10% of one’s funds, this really will not hurt. Even if it goes up 10 times, it is not going to make you very wealthy, as you have to start afresh with another speculation. As you continue speculating, the amount that you speculate increases. Then one day, Lady Luck may not smile at you anymore and you can lose everything you have built up.
If you speculate the market with 100% of your net worth, then you are really a very big risk taker and I really wish you the Best of Luck! For me, the only way I am willing to invest a significant percentage of my net worth is to invest in fundamentally sound stocks. To make each investment meaningful, I only hold a handful of stocks. As a collapse in any of these stocks can be very painful financially, I take my time to know the stocks well and then monitor them carefully after that.
Like it or not, there is no gain without risk. If you seek financial freedom, you have to put to risk a large chunk of your capital. To reduce the risk on this capital, you have to do your homework and believe in yourself and your selection of stocks. I have found this to be the least risky way of growing my capital.
Of course, if you are a multi-millionaire, you may think differently, as you would want to find ways of preserving your wealth and diversification under such circumstances would make some sense. But for those who are just starting out to build up their wealth, a focused investment strategy is more likely to give much better returns.
However, to be able to do this successfully, you must spend quality time understanding not only the companies that you invest in but also the mechanics of the stock market. There is no shortcut to financial freedom. If you don’t spend enough time understanding the markets or the companies that you invest in, it is unlikely that you can become a successful investor.