Monday, February 2, 2015

Pretend You Only Have 20 Investment Chances in Your Lifetime

We hear a lot of wise advice throughout our investment journey from what we feel as the best investor of all time, Warren Buffett. There are many of them which I vividly remember but there is one in particular which I thought was extremely going to be useful.




I came across the Buffett's analogy of punch card which I think is a brilliant mental framework for all investors to consider. In this analogy, he referred an investment selection as tickets which an investor has only 20 chances to make throughout his lifetime. Because of this limited selection, an investor will have to think twice or thrice before putting his money into the investment because it would force the investor to think much more than under the normal circumstances.

I think this is very much a reformed way of thinking about investing because it forces you to transform the thought process from "Is this stock a good selection to invest my money in right now" to "Is this stock the best selection I could choose to invest my money in right now". For instance, when we think about investing in ST Eng, we think about whether the current PER of 18x is fair, whether the growth in the future is apparent, or whether the defensive downside is limited. It allowed our mind to think more about such questions because you will not be looking just for an average but great investment. After all, 20 chances is all you have to make it work or break.

This brings me to another point on whether as an investor you should have more than 10 or 15 stocks in a portfolio, or the lesser or more is better. For one thing, the general benchmark should be 30 local stocks in a portfolio because if you have more than this in your portfolio, you are probably over diversifying more than what the STI index is currently doing, which does not make absolute sense to me.

I personally have 10 local stocks currently in my portfolio but if I have to be selective, my top 4 holdings have 2/3 weightage of the overall portfolio. I personally like to revolve around this figure in the near future because beyond that point, not only you lose the point about diversification but also the focus that what you are actually holding is a business that you feel strongly about performing better in the long run. In other words, think about being a business partner for more than 10 companies and your attention will undoubtly get divided. If you are arguing about diversification, 10 should provide sufficient coverage for local stocks diversification, the rest should go beyond the different asset classes such as bonds or different geographical areas.

Some people have argued in spite of the sub-diversification they own they hsve remained focus on the selection of the wide variety of stocks they have in their portfolio. I believe them. Different people spend different amount of time on their "businesses" and the amount of effort he or she is willing to put in to understand the business. For me, I try to at least keep abreast of the daily news announcement coming out from the companies I own, industry research, quarterly results announcement, follow up with the investor relations and management about the constant business risk and future projections, attending the AGM, compare a few valuation methodology and writing my thoughts on this blog. That keeps me busy enough more than what I would have liked to.

As you get more experienced with investing, your test of skill, knowledge and emotions would have adjusted to the better of peak and trough of economic cycle. By then, maybe holding lesser shares in your portfolio with higher substantial amount would bring greater internal returns over the long run. After all, who spends that kind of effort if you are holding only a lot share of every piece of the business?

What about you? How many is an optimal figure based on your portfolio and liking?

24 comments:

  1. Hi B,

    I asked myself the same question before. The hypothetical answer is 20 stocks. So that any lemon will not wipe off theoretically more than 5% of portfolio.

    I have 9 or 10 in my portfolio (LOL) can't remember

    The problem is, as a retail investor, it is not easy to track 10 actively. Passive tracking is still "ok", so I placed high value in track records and dividends.

    As you can see in my port update, instead of buying more to diversify, I actually end up accumulating what I have existing due to the familiarity biased.

    After you have researched to your heart content on a company, the time required to keep track is much lesser, but to find a new counter, u need to look at competitors, customers etc... It's super lots of work!!

    So, I do not think I will ever reach 20 in the next 5-10 years. Maybe 10-15 is max.

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    1. Hi Sillyinvestor

      A 5% allocation out of 20 stocks is probably in the comfort level of most investors out there. The absolute amount probably plays a part especially if you have $1m or if you only have $10K.

      I think you have pointed out correctly regarding familiarity bias. It's very unlikely that one will do thorough research on companies if he/she doesn't own a big stake in the company. Usually one will revert back to companies which we know best, which isn't necessarily a bad thing at least.

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  3. Hello B,

    That's a question I've been thinking about over the past few days. I realize how tiring it is to monitor the developments on many S-Reits at once. I thought perhaps I should pool my resources and just keep a few counters that score the best on my checklist.

    My ideal number is 20 stocks in the portfolio. Not sure if that's too many or too little, since I've yet to reach that magical number in my portfolio. Lol

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    1. Hi SRSI

      I think the number of stocks you have in the portfolio shows how much conviction and belief you have towards a particular company you are invested in.

      Some people argued that they are for reducing economy or industry risk, but the fact that when bear comes, no companies are spared. I feel like they are more for reducing the known unknown risk in the company that we can hardly have access or predict.

      I started out with around 20 as well but think they are too much for a thorough monitoring even on a quarterly basis.

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  4. Invest to win or invest not to lose?

    Invest to win = less than 10 t0 15 stocks?

    Invest not to lose = more than 40 - 50 stocks? Applying law of large number.

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    1. Hi Uncle CW

      Investing not to lose is a confidence booster.

      Investing to win is a greed booster.

      People always start off by wanting to win but ended up the opposite, and they likely become more defensive naturally.

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    2. yeah very well said,
      if invest not to lose, then should diversify as much as possible to get market returns
      if invest to win, say to beat the index by 2-5% percentage points
      then focus is the way to go, say 10 or less stocks
      if buy 20-30 stocks... really hard to pick more than 10 stocks that can clearly outperform the index

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  5. I think with that mindset. I buy with the intention of having to hold for at least 10 years. But limiting my options to just 20... Hmmm... I think the world is just too large to limit your options. Then again, you only need one great investments to be successful.

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    1. Hi Henry

      I don't know in the US how much more closely you are able to get near to the management of the company and understand its business operations well than the others. I think larger cap companies like Coca Cola or BHP are very difficult to do so, so public information is the closest proxy.

      I think limiting invesment in good companies are silly, but these days as you pointed out we want to find great companies and ride with them. All it takes is just one great investment to cover a few of the poor investment.

      Delete
  6. Hi B,
    IMO,If my capital is 100,000, I think 5 counters is good enough, but for over a million I will prefer to have 20.

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    1. Hi Stock Hunter

      Ahh absolute figures comes into play.

      How would your conviction towards a particular investment differ when the amount gets larger. It's quite ironic that as we gets wealthier and more knowledge gained in investing, we spread out our portfolio larger. But 20 is still fine, I know some people who have 80-100.

      Delete
  7. Hi B,

    For me, one of the reasons to diversify (other than to reduce the risk of the specific company invested), is to limit the volatility of my portfolio in absolute terms.

    I do not like to see my portfolio moving a few percentage just because of some spikes in a company price movement. It just provides more peace of mind for me.

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    Replies
    1. Hi AlcusTrader

      I hear what you are saying.

      I think what you want is a steady increase upwards in your portfolio over time instead of more volatility. In that case, would an ETF work better for you instead? Since it probably solves the diversification and volatility issues and move up well over the long term.

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    2. Hi B,

      Yes, ETF is a good suggestion. :) The only problem with ETF is probably relatively low yield. Oh well, difficult to have our cake and eat it too. :P

      I guess this could be my option.

      Delete
    3. Hi AlcusTrader

      I think at some point in time I would try to incorporate the STI ETF in my portfolio. I think they are really decent.over the long term.

      Delete
  8. Hi B,

    That is a very interesting analogy by Warren Buffet. Unfortunately the thing is, I don't think it works really well because in the back of our minds, we always know that we can buy more than just 20 stocks.

    I think I have fallen prey to this. Right now my portfolio holds over 25 stocks and it's value is still under $50,000. Perhaps, its time I narrow down the companies in my portfolio. :)

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    1. Hi Jeff

      That's a pretty wide spread of 25 stocks there. But you've got more choices in the US with so many blue chips there. It's much lesser here and blue chips are very much overpriced so I don't generally look at that too much.

      I think you've done pretty solid so please keep it going. I'll be watching out for your next update.

      Delete
  9. Most of us may have 2 to 3 opportunities in our lifetime to make very significant impact to our investing results so don't waste the market crisis.

    We can't predict. We can prepare - Howard Marks

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    1. Do we wait or do we find? Or will the market eventually find and correct itself?

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  10. Very interesting concept but I would argue that buying 20 stocks isn't enough diversification. You're probably better off getting ETF in this case.

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    1. Hi Tawcan

      It really depends on which 20 stocks you are choosing. If they are all related to oil or energy stocks, then that is obviously not enough diversification. The Dow consists of the top 30 by vastly different industries, that should be the proxy for diversification.

      Thanks for visiting.

      Delete
  11. very good read, I also strongly believe in warren buffett's teachings. So each year I only try to make just 2-3 good bets, like last year I spoke about the China market, OCBC and SCI.

    This year I spoke about STE and Kep corp.

    My ideal portfolio size is only 5 stocks, very focused as compared to other full time investors. As my goal is to out perform the index (STI ETF).

    I used to hold 10-20 stocks and realize my performance tend to trend closely with the index instead... by holding just 5 stocks, the good picks will help a lot more in out performance

    however the downside is that if any 1 stock goes terribly wrong, I could lose 20% of portfolio~ so not for the weak hearted

    CHeers

    ReplyDelete
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    1. Hi Felix

      That is what I was trying to put across.

      I think it's difficult to pick companies that you are convinced are able to beat the index. Each and everyone of your picks must have that justification and obviously if you have 50 or 100, then I think you are over-stretching too much.

      I saw your article on this too btw. Same sentiments.

      Delete

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