Tag Archives: advice

How Many Stocks Should You Own? Remember Warren Buffett’s Advice

Summary Diversification is trumpeted as a key point of proper portfolio design. Warren Buffett disagrees with diversification, with a single caveat. The return spread among stocks suggest that every new holding you add is more likely to be a loser than a winner. If you asked SeekingAlpha readers why investors should own more than one stock, the overwhelming response would easily be diversification. The idea is simple: the more holdings you have, the less exposure you have to unsystematic risk (risk associated with a particular company or industry). Now, if you asked a follow-up question, “How many stock holdings you should have?”, you would end up with a hotly debated topic. On page 129 of my copy of The Intelligent Investor , legendary money manager Benjamin Graham advocates holding 10 to 30 positions. Modern portfolio theory supported this advice, and many continue to follow its preachings religiously. According to this theory, if you own 20 well-diversified companies, each held in equal amounts, you’ve eliminated 70% of risk (as measured by standard deviation) and reduced volatility. Can’t argue with the math (or can you?), and diversification has been harped on by many as the foundation of any properly constructed portfolio. It is likely that anyone that has had a financial advisor or even discussed finances with a family friend has heard this advice before. Always spread your capital across multiple sectors and markets is in that person’s best interest. Makes sense right? Who doesn’t want less volatility and risk? Warren Buffett apparently. “Diversification is protection against ignorance. It makes very little sense for those who know what they’re doing.” – The Oracle of Omaha Himself So, Do You Know What You’re Doing? Of course, modern portfolio theory and its offshoots were theorized between the ’50s and ’70s. Volatility is up since then, and stocks have become increasingly uncorrelated with the underlying market. To more clearly illustrate this point, stocks increasingly don’t follow a normal distribution pattern: * Source: Investopedia The results of the above image have been repeated over and over in recent market studies. The key takeaway for an individual investor is that the odds of a stock you own outperforming the stock market is actually worse than 50/50 , contrary to what many investors might think off hand. The reason for this is because overall market returns have been boosted by just a handful of “superstar” stocks, like Apple (NASDAQ: AAPL ) or Microsoft (NASDAQ: MSFT ). If you don’t own something like the next Apple or Microsoft in your portfolio (roughly 1 in 16 odds), then well, you’re likely doomed to underperform. So if you have a portfolio of 16 stocks, what are the odds you have that one in sixteen superstar company included based on random chance? Just 38%. Let us say you get lucky and manage to stumble upon a superstar. Now the question is whether you will continue to hold it as it multiplies. Enter the disposition effect . Retail investors have a tendency to sell winners (realizing gains too early) and hold onto losers, following the thought process that today’s losers are tomorrow’s winners. How many investors held on to Apple from $7.00/share in the early 2000’s all the way up to more than $700.00/share (split-adjusted) today? The answer is likely very few. Retail investors took the profit from the double or triple (if they even held that long) and likely didn’t reinvest back in because they had sold in the past. None of this changes the fact that the more companies you own, the more you will inevitably track the index of the positions you hold. In order to generate alpha (abnormal return adjusted for risk), it is a fact that the more stocks you own, the less likely you will be able to generate that alpha. The more holdings you have, the more likely you will have just tracked the index that your holdings are a part of, but in an inefficient way. For all your trouble, you are out both your free time and likely higher trading costs. The question then is why bother with all the headaches of investing in numerous individual companies you buy individually, if you could simply just buy the index and take it easy? If you take a look at major hedge fund and money manager holdings, it is clear that concentrated holdings are used to drive alpha. Visiting the Oracle of Omaha’s portfolio, the man clearly practices what he says. The top five holdings of Berkshire Hathaway (NYSE: BRK.A ) (NYSE: BRK.B )[Wells Fargo (NYSE: WFC ), Kraft Heinz (NASDAQ: KHC ), Coca Cola (NYSE: KO ), IBM (NYSE: IBM ), and American Express (NYSE: AXP )] constituted 67% of his portfolio as of September 30, 2015. 43 scattered holdings constituted the remaining 33%. As for diversifying across sectors versus buying what you know and understand, 37% of Buffett’s holdings fall in the Consumer Staples sector and 35% in Financials. The man clearly doesn’t buy utilities just because portfolio theory tells him he should in order to reduce his risk. Conclusion Thousands of people will read this article. Are you smarter than two thirds of them? If you don’t believe that, buy ETFs, sit back, and be content with market returns. If you think you’re smarter than two thirds of readers of this article (I suspect 95% of you believe that), then the takeaway is slightly different. Diversification, for the sake of diversification, is stupid. Buy what you know, can understand, and believe in the long-term potential of. Don’t understand bank stocks? Reading their SEC filings even gives me headaches, and I work at one. If you don’t understand the company, chances are you aren’t going to pick a winner other than by dumb luck. You shouldn’t lose sleep at night for not having exposure to an industry you can’t adequately review, and it is likely your portfolio returns will thank you for it. As far as how many positions to have, hold as few positions as you are comfortable with when it comes to risk and volatility in order to increase alpha on your high conviction positions. For most investors, that sweet spot still likely falls within modern portfolio theory guidance, around 15 to 25.

10 Ways To Destroy Your Portfolio

With the increased frequency of heightened volatility, investing has never been as challenging as it is today. However, the importance of investing has never been more crucial either, due to rising life expectancies, corrosive effects of inflation, and the uncertainty surrounding the sustainability of government programs like Social Security, Medicare, and pensions. If you are not wasting enough money from our structurally flawed and loosely regulated investment industry that is inundated with conflicts of interest, here are 10 additional ways to destroy your investment portfolio: #1. Watch and React to Sensationalist News Stories: Typically, strategists and pundits do a wonderful job of parroting the consensus du jour. With the advent of the internet, and 24/7 news cycles, it is difficult to not get caught up in the daily vicissitudes. However, the accuracy of the so-called media experts is no better than weather forecasters’ accuracy in predicting the weather three Saturdays from now at 10:23 a.m. Investors would be better served by listening to and learning from successful, seasoned veterans. #2. Invest for the Short Term and Attempt Market Timing: Investing is a marathon, and not a sprint, yet countless investors have the arrogance to believe they can time the market. A few get lucky and time the proper entry point, but the same investors often fail to time the appropriate exit point. The process works similarly in reverse, which hammers home the idea that you can be 200% wrong when you are constantly switching your portfolio positions. #3. Blindly Invest Without Knowing Fees: Like a dripping faucet, fees, transaction costs, taxes, and other charges may not be noticeable in the short-run, but combined, these portfolio expenses can be devastating in the long run. Whether you or your broker/advisor knowingly or unknowingly is churning your account, the practice should be immediately halted. Passive investment products and strategies like ETFs (Exchange Traded Funds), index funds, and low turnover (long time horizon / tax-efficient) investing strategies are the way to go for investors. #4. Use Technical Analysis as a Primary Strategy: Warren Buffett openly recognizes the problem with technical analysis as evidenced by his statement, “I realized technical analysis didn’t work when I turned the charts upside down and didn’t get a different answer.” Legendary fund manager Peter Lynch adds, “Charts are great for predicting the past.” Most indicators are about as helpful as astrology, but in rare instances some facets can serve as a useful device (like a Lob Wedge in golf). #5. Panic-Sell out of Fear And Panic-Buy out of Greed: Emotions can devastate portfolio returns when investors’ trading activity follows the herd in good times and bad. As the old saying goes, “Following the herd often leads to the slaughterhouse.” Gary Helms rightly identifies the role that overconfidence plays when in investing when he states, “If you have a great thought and write it down, it will look stupid 10 hours later.” The best investment returns are earned by traveling down the less followed path. Or as Rob Arnott describes, “In investing, what is comfortable is rarely profitable.” Get a broad range of opinions and continually test your investment thesis to make sure peer pressure is not driving key investment decisions. #6. Ignore Valuation and Yield: Valuation is like good pitching in baseball…very important. Valuation may not cause all of your investments to win, but this factor should be an integral part of your investment process. Successful investors think about valuation similarly to skilled sports handicappers. Steven Crist summed it up beautifully when he said, “There are no ‘good’ or ‘bad’ horses, just correctly- or incorrectly-priced ones.” The same principle applies to investments. Dividends and yields should not be overlooked – these elements are an essential part of an investor’s long-run total return. #7. Buy and Forget: “Buy-and-hold” is good for stocks that go up in price, and bad for stocks that go flat or decline in value. Wow, how deeply profound. As I have written in the past, there are always reasons of why you should not invest for the long term and instead sell your position, such as: 1) new competition; 2) cost pressures; 3) slowing growth; 4) management change; 5) excessive valuation; 6) change in industry regulation; 7) slowing economy; 8) loss of market share; 9) product obsolescence; 10) etc, etc, etc. You get the idea. #8. Over-Concentrate Your Portfolio: If you own a top-heavy portfolio with large weightings, sleeping at night can be challenging, and also force average investors to make bad decisions at the wrong times (i.e., buy high and sell low). While over-concentration can be risky, over-diversification can eat away at performance as well – owning a 100 different mutual funds is costly and inefficient. #9. Stuff Money Under Your Mattress: With interest rates at the lowest levels in a generation, stuffing money under the mattress in the form of CDs (Certificates of Deposit), money market accounts, and low-yielding Treasuries that are earning next to nothing is counter-productive for many investors. Compounding this problem is inflation, a silent killer that will quietly disintegrate your hard earned investment portfolio. In other words, a penny saved inefficiently will lead to a penny depreciating rapidly. #10. Forget Your Mistakes: Investing is difficult enough without naively repeating the same mistakes. As Albert Einstein said, “Insanity is doing the same thing, over and over again, but expecting different results.” Mistakes will be made and it behooves investors to document them and learn from them. Brushing your mistakes under the carpet may make you temporarily feel better emotionally, but will not help your financial returns. As the year approaches a close, do yourself a favor and evaluate whether you are committing any of these damaging habits. Investing is tough enough already, without adding further ways of destroying your portfolio. Disclosure: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

A Perfect Starting Portfolio For The Young, Long-Term Investor

Summary Of supermarkets and stock exchanges. Of what does the perfect starting portfolio consist? Personal recommendations. The other day I walked into a supermarket with a clear, self-given mandate to buy only three essentials: coffee, cottage cheese, and birthday-cake flavored oreos. While walking through the aisles, I couldn’t help but be enticed to buy all sorts of things for which I had no real need. It isn’t as though these things didn’t have merit or that I didn’t consider them worth the money, but it was simply the case that at the time those other items would have been superfluous to my goals. In like manner, there are thousands of companies that have exciting prospects. There are thousands of companies that could benefit from a trend that you see in the future, or whose products you know and love. If you’re like me, you don’t have enough money in your IRA to invest individually in all those companies, and there’s the rub (as Bill Shakespeare would say). I left the supermarket that evening, essentials in hand and head held high, because I knew what I wanted, and refrained from deviating from that. Walking out, I thought about how grocery shopping applied to building a portfolio, a similar situation in which we are continuously buffeted with advice and rhetoric. The purpose of this post is not to tell you what to buy. That went out the window when I showed how partial I am to cottage cheese and BCOs (try the latter and this will all make sense). What I do aim to accomplish, is to show how building the perfect portfolio starting out doesn’t have to be so difficult. All that is required is that you know what you want to achieve, and how to achieve it. In the last section, I will tied it all together with a ten-company portfolio that meets my goals for core holdings. What do I want, again??? Formulating a strategy for investing is easier said than done. There are many legitimate investment motifs that are frequently employed. I have been more inclined towards different ones over the past years: event-driven, dividend growth oriented, and macroeconomic trends to name a few. Perhaps it is just me being young, but I find it easy to lose the forest for the trees. What I have come to believe is that I need a core portfolio before I venture into themed investment. It is far too easy to lose patience and become distracted by a prospective investment without a core group of holdings. The purpose of long-term investment is to capitalize on compounding gains, and the thrill and corresponding quick gain from correctly interpreting an event or recognizing a short-term trend can’t match the long-term value of compound gains. The long-term value of a company lies in sustained growth of earnings. These considerations in mind, I set about to establish the characteristics of companies in the core portfolio I will be putting together piecemeal in the coming months. Like many others, I have been wary of high historical valuations caused by loose economic policy, as well as brewing global tumult in emerging markets. I do believe these are significant over-arching risks, but that is why a long-term portfolio is so attractive. Value for the long haul can subsist through economic downturns. What I look for in my retirement portfolio Word to the wise: In my opinion this should be ancillary to a 401K. I would much rather diversify within a 401K and leave this type of portfolio as a Roth IRA. Higher ceiling, but higher risk. To get to the crux of the matter, these are the characteristics I want to see of companies in my starting retirement portfolio, with a quick summary of what each means to me: Established American companies : I stick to what I know, which carries less risk. Another consideration is that investing in a foreign company will add currency considerations to earnings and dividends. Reasonably valued : I don’t want to buy something which has its future growth already paid for. As future earnings are of consummate importance, I will reference p/e for simplicity’s sake. Diversified through sectors : Using Morningstar’s 11 sectors , I seek to achieve business diversification. Combining communication services and utilities will give us a round 10 companies to own. Longevity (35 years) : Quite simply: I want the company to be still around (and growing) in 35 years. Well-managed : Concept and execution. The greatest ideas still need skillful execution to be profitable for long time frames. Prospects for continued growth : One has to try to look into the future, not just be stuck gazing into the rear view. Commitment to shareholders : Dividends help with compound gains. Buybacks can be beneficial. One company does neither and makes the list. I believe these expectations can lead to a well-rounded beginning portfolio that can be held for the long-term. Once you set expectations for yourself, I encourage you to dive in to the company’s financials, current and future projects, and the stated business model for each. Due diligence is crucial for the long-term investor. My perfect starting portfolio Without further ado, I will list out the portfolio I will be adding piecemeal into my Roth IRA, highlighted by sector for the sake of organization. The purpose of this article is not to spell out every aspect, positive or negative, of each company, but simply to spell out why it makes the cut over all the others. In-depth analysis regarding financial soundness, attractive valuation, and future prospects should be done by every individual investor; there are also articles on Seeking Alpha for every one of these companies to consider. Basic Materials: The Dow Chemical Company (NYSE: DOW ) My thought is that basic materials as a whole can be a tricky sector, whose performance is dependent largely upon the prices of underlying commodities. A company like Alcoa (NYSE: AA ) is at the mercy of aluminum for its performance. Chemicals are always in demand, and a company like Dow, which has been around since 1897, knows how to run a business. Via Yahoo! Finance: “It serves automotive, electronics and entertainment, healthcare and medical, and personal and home care goods markets.” Dow ticks all the boxes, and a 3.5%+ dividend doesn’t hurt, adding a margin of safety to a reputable company with lasting prospects. Consumer Cyclicals: The Walt Disney Company (NYSE: DIS ) My thought is that Disney is one of the best-managed companies out there. Not only have they been around for almost a century, they have shown an ageless quality stemming from changing with the times. Smart acquisitions like Marvel have paid for themselves. Diversification of the business into cruise lines, blockbuster movies, theme parks, and sports broadcasting and web presence (OTC: ESPN ), promise a growing business for decades. They are also aggressive in their dividend hikes because of all that cash flow. P/E is a little steep at 22, but the historical average is surprisingly higher at 26. Consumer Defensive: Service Corporation International (NYSE: SCI ) My thought is that SCI is in the most defensive industry there is: Deathcare. This industry will be bolstered for the next 15 years with a heightening mortality rate, as Baby Boomers reach more advanced age, so it doubles as a demographic trend pick. As for the company itself, it was recommended by Peter Lynch in the late 1980’s and his advice remains as relevant today as it was then. This will be the one pick you won’t find a lot about here on SA, but for further reading I would suggest my article here . Energy: Exxon Mobil (NYSE: XOM ) My thought is that Exxon is far and away the best-run energy company. The company has a AAA credit rating, which is better than the sovereign credit rating of the United States of America. My worries about the future of energy stop at the rock-solid financials and disciplined business approach of Exxon Mobil. The dividend isn’t the highest in the beaten-down energy sector, but they’ve raised it for 32 years straight, and that is through quite a few tumultuous times. Financial Services: Berkshire Hathaway Inc. (NYSE: BRK.B ) (NYSE: BRK.A ) My thought is that actually having little to do with Buffett. The sage octogenarian has a jaw-dropping track record, but his company’s earnings will continue long after he is no longer at the helm. This pick is sort of a cheat for the sector, since I see Berkshire’s strength in its diversity of businesses, not in a traditional financial services way. I myself work in the financial services industry, and I feel a lot of things are changing for the future. Insurance won’t be one of those things, and neither will railroads, Heinz, or a great number of other companies under the Berkshire umbrella. Healthcare: Johnson & Johnson (NYSE: JNJ ) My thought is that I don’t trust biotech. I couldn’t put any biotech in my 35-year timeframe, because R&D is so pivotal to earnings. The Johnson & Johnson brand, with its plethora of constituents, is dependent on people getting cuts, washing their babies, and getting sick with colds and headaches. They also have medical device and pharmaceutical segments, too, so they may not be a biotech, but they will have new products in their pipeline. In the fantasy football world one would say they have a high ceiling and a high floor, so I’m comfortable making them one of these top ten draft picks for my portfolio. Their dividend is about the most sure thing you can find in this life. Industrials: Honeywell International (NYSE: HON ) My thought is that industrials is a hard sector to reduce to one choice. GE, Boeing, and Lockheed Martin could just as easily make this list. I chose Honeywell because I think their prospects are so multi-faceted that to not have them in a portfolio is an oversight. I don’t even have room to talk about all of the segments that Honeywell operates in here, but their diversification, longevity, and integration with technologies that might become dominant very soon make them almost a sure-fire wonderful investment. You can read about why they would be the one dividend stock Adam Aloisi would own here . That’s quite a vote of confidence. Real Estate: Realty Income Corporation (NYSE: O ) My thought is that Realty Income has enough articles on Seeking Alpha that they should be paying the site. The “Monthly Dividend Company” is a darling of the site for good reason: their business model is airtight and low-risk. It is a little bit like a real estate mogul who owns properties, and renting them out, can sit back and collect the checks. Well Realty Income shares 90% of those checks with its shareholders, and has done so since 1994. They expand, but not over-aggressively, and their occupancy rate has never dipped under 96.6% for any year. They are likely the most shareholder-friendly company out there, as can be easily seen from their site . Technology: Alphabet Inc (NASDAQ: GOOGL ) My thought is that Alphabet beats out Apple Inc. as the tech stock to own for 35 years. They own information, and we are in the information age. They are the company everyone wants to work for, so they will (and do) attract the brightest talent. Owning a monopoly on information will allow Alphabet to really do whatever they want, which is a scary but lucrative proposition. They added a verb to the English language. They are also cash-heavy, but have the ideas and reputation to put that to good use for the future. They have only been public for 11 years : crazy to think about, but it’s still in its infancy. It has tremendous growth ahead. Telecom/Utilities: AT&T (NYSE: T ) My thought is that utilities are honestly quite dull and growth is mainly in the future. Within the telecom industry, however, AT&T beats out Verizon as my pseudo utility/telecom I want to own. They have rolled with the punches of technology and monopoly allegations, keeping a rock-solid dividend and growing through advertising and related acquisitions. The DirecTV (NASDAQ: DTV ) acquisition should boost the cash flows of this juggernaut, allowing the 5.5% dividend to keep growing. So there you have the ten companies I would recommend as the perfect starting portfolio for the young, long-term investor. I will reiterate: Do your due diligence. I may find some qualities more attractive in companies I want to own than you do. Personally, I will be buying these companies over the next few months. Looking forward to comments from everyone!