Tag Archives: security

Smart Beta Vs. Ben Graham

Summary “Smart Beta” and systematic investing strategies have become wildly popular in recent years. The trend has largely been driven by technological improvements and positive feedback loops. There are risks to systematic investing that must be acknowledged. Most importantly, systematic investors must acknowledge that stocks are not pieces of data, probabilities, or bets. They are legally, tangibly, and truly ownership interests in businesses. The Rise of Systematic Strategies According to Investopedia , “smart beta” was the most searched for financial term of 2015. Smart beta funds and ETFs are popping up all over the place. According to CNBC (emphasis mine) : As of June [2015], there were 444 strategic/smart beta ETFs in the market managing about $450 billion , according to Morningstar data. That’s up from 213 funds managing $132.5 billion in assets in 2009. They now account for 21 percent of all exchange-traded products and about 31 percent of all cash currently flowing into the industry . Anecdotally, fund companies like Gerstein Fisher (MUTF: GFMGX ) that have employed smart beta-like strategies for decades have suddenly seen a pouring in of assets. Before we go any further, what is smart beta? Investopedia defines it as follows: Smart beta defines a set of investment strategies that emphasize the use of alternative index construction rules to traditional market capitalization based indices. Smart beta emphasizes capturing investment factors or market inefficiencies in a rules-based and transparent way. The increased popularity of smart beta is linked to a desire for portfolio risk management and diversification along factor dimensions as well as seeking to enhance risk-adjusted returns above cap-weighted indices. It is a very general marketing term to describe (1) passive strategies (no active individual security selection) that (2) construct portfolios using weighting methods and metrics other than market capitalization weighting. Traditional indices are market weighted, and this has been observed to be detrimental to performance compared to equal weighting or fundamental-based weighting. By weighting, I mean the size of each position in the portfolio. An example of smart beta would be taking the 500 stocks in the S&P 500 (NYSEARCA: SPY ), but instead of assigning weights based on the market capitalizations (ex: Apple (NASDAQ: AAPL ) would be ~3% of the portfolio), you could weight the portfolio by LTM net income. For the purposes of this article, I’m more interested in smart beta for the general strategy and secular shift it represents – a shift toward systematic investment strategies that aren’t indexing, but aren’t individual security selection either. Outside of “smart beta” specifically, systematic strategies in general have become very popular. The success of Michael Covel’s Trend Following products and books, Tobias Carlisle’s The Acquirer’s Multiple product and books, Wesley Gray’s Alpha Architect , Joel Greenblatt’s Magic Formula and Gotham Funds (MUTF: GARIX ), etc. are evidence of this. What about the most popular investing blogs? Abnormal Returns , Pragmatic Capitalism , A Wealth of Common Sense . All these blogs have a systematic/passive bent. It seems to me that in the last year or two, systematic, rules-based strategies have become enormously popular. Maybe I didn’t have my eyes open before then, but now I can’t seem to avoid this stuff. Why? Technology. The rise is largely the result of technological improvements. Systematic strategies are fundamentally empirical. They require historical data and a backtest to answer the question “What’s worked in the past?” Technological improvements have made this possible. It’s now very easy to run a backtest on a Bloomberg terminal. More serious backtesters can use the extensive databases of Compustat and UChicago’s Center for Research in Security Prices (CRSP). And this feeds on itself, because people who do the research and backtests often publish their results, which are then used by other investors. So, more and more people have various answers to the question mentioned above and, naturally, more desire to do something with it. The other question: Is there a way we can run this strategy without human interference – fully automated? This is important because it’s difficult to manually follow a systematic strategy that involves purchasing hundreds of securities at potentially very short intervals, calculating weights, etc. It’s just not that feasible to do it manually. Technological improvements have made this feasible as well. I’m not so sure I understand the specifics of how this is done, but clearly, if hundreds of firms are doing it at much lower expense ratios than traditional actively-managed funds, there is automation involved. And this feeds on itself too. Once a fund/ETF has figured out how to do it, other investors can just buy into that ETF to participate in systematic investing. Personal Reflection This all is reflected in my recent articles and the evolution of my investment strategy. Being exposed to all of this has deeply influenced me. I also think, as I mentioned in a prior article, beginning to playing poker (a deeply probabilistic game) has had a significant impact. I’ve begun sourcing stocks using screens filtered by metrics that outperform, like EV/EBIT. I’ve begun taking small starter positions or bets, and looking at aggregate performance instead of performance by position. Put simply, I’ve begun to think of investments as bets and the future probabilistically. I’ve become empirical. Risks There is a lot of good in this transition, but I’m realizing now that it is dangerous if taken too far. Historical data is great, but there are risks to it. One is data mining, which I discussed in my article on stock screening. It’s worth googling “Butter in Bangladesh.” Then, there’s execution risk. What if your technology is flawed? What if there’s a power outage or you experience a data breach a la Target (NYSE: TGT )? What if you override the system at all? Joel Greenblatt points out that when he and his colleagues tried to source from Magic Formula without buying all the stocks on the list, the performance of the stocks they picked actually underperformed the market despite MF in aggregate outperforming, because they tended to avoid the biggest outperformers. They were the hairiest, and that’s why they performed so well. What if the markets change? The predictive power of metrics like P/B, which Fama and French articulated decades ago, has greatly diminished since. Past performance does not predict future performance. This is particularly important given the shift toward systematic strategies. The more popular these strategies get, the quicker the excess returns will be arbitraged away. Don’t assume you can stick to it either. It’s great looking at 50 years of data and seeing that over that period, the strategy has substantially outperformed the S&P, but that doesn’t mean there weren’t extended periods of substantial underperformance. In fact, most studies point out these spots of underperformance. One of my favorite quotes by Ben Carlson is this: The advice is to think and act for the long-term, which sounds great on paper, but the problem is that life isn’t lived in the long-term, it’s lived in the short-term… The problem is not the knowledge, it’s the behavior. Quitting smoking is not hard because people don’t know it’s bad for them, it’s hard because it’s habitual and it’s hard to change those bad habits. If you employ a systematic strategy, it’s because you think it will perform better than something else (most likely S&P 500) in terms of return, drawdown, etc. Naturally, you’ll be prone to comparing the performance of the strategy to that benchmark fairly frequently, and it will be difficult to see that it is performing worse over an extended period and still stick to it. To make this point more tangible, let’s use an example. You implement traditional Magic Formula (30 stocks, equal weight, annual rebalancing) with the expectation that your annual returns will substantially exceed the S&P 500. 4 years into implementation, you’ve underperformed in every single year (very possible) and cumulatively, the S&P 500 is up 15% annually and you are only up 8% annually. Unlike a fundamental research-driven active investor, you can’t explain this away with mistakes (“My current investment strategy works, I’ve just made mistakes and bad decisions along the way. My strategy is improved now and I’m more knowledgeable and experienced. I’ll do better going forward.”) The only thing you can do is question whether the selection criteria you are using still work. You only have four more years of data – data that disproves your initial hypothesis. That’s it. On top of that, clients and peers are badgering you about it. Surely, it’s difficult to stick to the strategy. Moreover, even if you want to stick to the strategy, there’s a good chance your clients don’t and they pull their money. At this point, you’ve stopped using the strategy at the worst time possible and managed to achieve underperformance with a strategy that has outperformed in the past and will likely outperform in the future. Stocks are Ownership Interests in Businesses I don’t mean to say that the empirical evidence is not compelling. It is. Some of these backtests encompass many decades and market cycles. Carlisle and Gray’s backtests in Quantitative Value are over 50 years. I also don’t mean to say that completely systematic strategies can’t work in practice. They can. The best example is probably Jim Simons’ Renaissance Technologies. The flagship Medallion fund did 72% annual returns before fees over a 20-year period from 1994 to 2014! What I am saying is that I don’t think a completely empirical approach to investing is sound, at least for me. There are too many things that can go wrong if we just leave it at this. Ultimately, stocks are ownership interests in businesses, not probabilities or bets. Maybe stocks can be thought of as probabilistic bets as a working assumption for a strategy, but that’s not what they actually are. A stock is legally, tangibly, and truly an ownership interest in a business. Ben Graham said this decades ago, and Buffett has singled it out as one of the 2-3 most important concepts to be learned from Graham. I think a much more sound approach to investing for empirically-driven, systematic investors is an upfront acknowledgement that goes something like this: Stocks are ownership interests in businesses. Stocks increase in price when the value of the underlying business increases or when there is a gap between the price of the stock and the value of the business and that gap closes. That is what is actually happening. As an investor, I have the opportunity to look at individual stocks and try to buy those whose prices do not fully reflect what the value of the underlying business is or will be. However, there is a wealth of data from historical markets that can be used to systematically identify these types of attractive situations. I feel, for various reasons, that these historical relationships are compelling and will continue to be. I also feel that I will be more successful as an investor using these systematic shortcuts than I would be if I tried to identify individual cases of undervaluation manually. The bottom line is that no matter who you are or how you invest, you need to acknowledge stocks for what they really are: ownership interests in businesses.

4 Key Reasons To Consider Market Neutral Investing

Summary The Invesco Quantitative Strategies team believes one way to buffer the effects of market downturns, volatility and rising interest rates is to add market neutral equity strategies to traditional portfolios. The strategies may offer several potential benefits to investor portfolios, including diversification from traditional asset classes, ability to dampen volatility, cushion against equity market declines and boost from rising rates. We believe a market neutral equity strategy can be an excellent diversification tool that enables investors to pursue increased returns from assets that respond differently to changing markets. Low correlation, downside protection and rising rate performance among key benefits By Kenneth Masse, Client Portfolio Manager The market downturn and ensuing volatility in the third quarter of 2015 is a timely reminder about the benefits of diversifying your portfolio with investment strategies that are expected to exhibit little-to-no correlation with the broad equity and bond markets. Moreover, as the US enters the late innings of its current economic growth cycle, many professional and individual investors are expecting lower returns from equities going forward than they’ve enjoyed over the last few years. These lowered expectations are on top of concern about what will happen to investors’ bond holdings when today’s historically low interest rates eventually rise. The Invesco Quantitative Strategies team believes one potential way to buffer the effects of market downturns, volatility and rising interest rates is to add market neutral equity strategies to traditional portfolios, as they potentially offer a unique approach to generating return regardless of the general movements of the equity and bond markets. In this blog, I outline four of the top reasons to consider market neutral equity strategies: 1. They have very low levels of correlation to other asset classes One of the ways investors attempt to manage and mitigate risk is by combining strategies that differ within and across asset classes to help diversify their return pattern over time. Using this approach, investors’ wealth creation is not tied to the fortunes of just one or a few investment options. Since market neutral strategies typically seek to eliminate exposure to the broader market, these strategies have also delivered attractively low levels of correlation, not only to the equity markets, but to other broad asset classes as well. As shown in Figure 1, from January 1997 to August 2015, market neutral strategies had only a 0.18 correlation to equities and a 0.04 correlation to bonds. Market neutral also had low correlation to another popular asset class, commodities, as well as to other segments of the fixed income market, such as leveraged loans and high yield. As investors seek to diversify their holdings in order to lower overall volatility, we believe market neutral strategies should be considered as a way to achieve that goal. Sources: Invesco and StyleADVISOR. (January 1997 – August 2015) BarclayHedge Alternative Investment Database. Past performance is not a guarantee of future results. Investments cannot be made directly into an index. 2. They may offer lower levels of total volatility Another way to potentially mitigate risk across an investment lineup is to include strategies that may offer lower levels of total volatility (variation in portfolio returns). Even if these strategies were perfectly correlated with other investments, their potentially lower total volatility profile could help lower the overall average volatility of the full lineup. Market neutral strategies also may be appealing to investors from this total volatility perspective, as their volatility has tended to be less than the broader equity markets, and in some cases, similar to broad fixed income indexes (see Figure 2). Furthermore, since market neutral returns are expected to be independent of the broader equity market, a spike in market-level volatility may not necessarily mean a spike in market neutral volatility. Sources: Invesco and StyleADVISOR. (January 1997 – August 2015). BarclayHedge Alternative Investment Database. Past performance is not a guarantee of future results. Investments cannot be made directly into an index. 3. They have a history of attractive downside protection during extreme market stress Another often-cited potential benefit of market neutral is that the strategies may offer investors a way to mitigate severe losses during a sharp equity market sell-off. Because these strategies typically have beta exposure to the market that hovers around zero, a big drop (or surge) in equities should not influence the performance of the strategy. This contrasts sharply with traditional, benchmark-centric strategies, which typically have very high levels of market exposure and tend to vary similarly to the broader market. Sources: Invesco and StyleADVISOR. January 1997 – August 2015. BarclayHedge Alternative Investment Database. Past performance is not a guarantee of future results. Investments cannot be made directly into an index. 4. They can provide an opportunity for higher returns in a rising interest rate environment. We believe an increase in the federal funds rate from the US Federal Reserve is inevitable; at this point it’s simply a matter of when and by how much. For market neutral equity strategies, a rise in interest rates – specifically short-term interest rates – can potentially provide a boost to returns. This occurs when market neutral equity strategies short a stock and receive proceeds from that sale. Those proceeds typically earn a rate of return tied to the prevailing short-term interest rate, such as the fed funds rate. When that rate increases, so does the interest earned by market neutral equity strategies on their short sale proceeds Key takeaway We believe a market neutral equity strategy is a valuable complement to a traditional portfolio of stocks and bonds, as well as an excellent diversification tool that enables investors to pursue increased returns from assets that respond differently to changing market conditions. Such characteristics may be important to today’s investors given the recent market downturn, volatility and expectation of rising interest rates. Important information Beta is a measure of risk representing how a security is expected to respond to general market movements. Correlation is the degree to which two investments have historically moved in relation to each other. Volatility measures the amount of fluctuation in the price of a security or portfolio over time. The S&P 500® Index is an unmanaged index considered representative of the US stock market. The S&P/LSTA US Leveraged Loan 100 Index is representative of the performance of the largest facilities in the leveraged loan market. The S&P GSCI Index is an unmanaged world production-weighted index composed of the principal physical commodities that are the subject of active, liquid futures markets. The BofA Merrill Lynch US High Yield Index tracks the performance of US dollar-denominated, below-investment-grade corporate debt publicly issued in the US domestic market. BarclayHedge Alternative Investment Database is a computerized database that tracks and analyzes the performance of approximately 6800 hedge fund and managed futures investment programs worldwide. BarclayHedge has created and regularly updates 18 proprietary hedge fund indices and 10 managed futures indices. BarclayHedge indexes reflect performance of hedge funds, not of retail investment strategies, and are used for illustrative purposes only solely as points of reference in evaluating alternative investment strategies. Please note: BarclayHedge is not affiliated with Barclays Bank or any of its affiliated entities. Performance for funds included in the BarclayHedge indices is reported underlying fees in net of fees. About risk Commodities may subject an investor to greater volatility than traditional securities such as stocks and bonds and can fluctuate significantly based on weather, political, tax, and other regulatory and market developments. Fixed-income investments are subject to credit risk of the issuer and the effects of changing interest rates. Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa. An issuer may be unable to meet interest and/or principal payments, thereby causing its instruments to decrease in value and lowering the issuer’s credit rating. Most senior loans are made to corporations with below investment-grade credit ratings and are subject to significant credit, valuation and liquidity risk. The value of the collateral securing a loan may not be sufficient to cover the amount owed, may be found invalid or may be used to pay other outstanding obligations of the borrower under applicable law. There is also the risk that the collateral may be difficult to liquidate, or that a majority of the collateral may be illiquid. Junk bonds involve a greater risk of default or price changes due to changes in the issuer’s credit quality. The values of junk bonds fluctuate more than those of high quality bonds and can decline significantly over short time periods. Derivatives may be more volatile and less liquid than traditional investments and are subject to market, interest rate, credit, leverage, counterparty and management risks. An investment in a derivative could lose more than the cash amount invested. Short sales may cause the fund to repurchase a security at a higher price, causing a loss. As there is no limit on how much the price of the security can increase, the fund’s exposure is unlimited. The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals. NOT FDIC INSURED MAY LOSE VALUE NO BANK GUARANTEE All data provided by Invesco unless otherwise noted. Invesco Distributors, Inc. is the US distributor for Invesco Ltd.’s retail products and collective trust funds. Invesco Advisers, Inc. and other affiliated investment advisers mentioned provide investment advisory services and do not sell securities. Invesco Unit Investment Trusts are distributed by the sponsor, Invesco Capital Markets, Inc., and broker-dealers including Invesco Distributors, Inc. PowerShares® is a registered trademark of Invesco PowerShares Capital Management LLC (Invesco PowerShares). Each entity is an indirect, wholly owned subsidiary of Invesco Ltd. ©2015 Invesco Ltd. All rights reserved. Four key reasons to consider market neutral investing by Invesco Blog

The Making Of A Value Investor: The 2015 Edition

Summary Looking back at the last 18 months this is what I learned, in the order I wish I learned it. I discuss my thoughts on: framework, where to search for stocks, how to analyze them, portfolio sizing, etc. I share some of my favorite books and Seeking Alpha authors. I started my quest to becoming an investor during the Summer of 2014. Since then, I have read countless books, chosen financial markets as my major, met multiple hedge fund managers, became a contributor for Seeking Alpha, and most importantly started investing. Along the way I have learned much. Looking back at the last 18 months, I asked myself, if I had to do it all again, where would I start? This is my best answer, my try at a roadmap, and a few lessons I learned along the way. If I learn as much in the next year, I will be satisfied. I hope this will be helpful to readers just starting out. I also hope it will help readers get to know me as a Contributor. I. A Value Investor’s Framework. Warren Buffett’s notoriety helped me get started. As I was facing the mountain of information available in books and online, it was extremely overwhelming to figure out where to start. So I picked Buffett. My rationale was straightforward: This guy obviously figured it out, so what are his tricks? What are his secrets? Quickly enough I was led to Graham’s book: The intelligent investor. You’ll meet very few people with an interest in the stock market who will admit to not having read the book. Everyone has an opinion on it too: some say it is the cornerstone of value investing. Others say it’s outdated, and that there is no such thing as net-net anymore. I read it. The real lessons were in between the lines. The magical secret that I thought would make me a zillionaire by the end of the month didn’t exist. My key takeaway is that being a successful investor is function of your state of mind more than the tools at your disposal. Source: Sheknows.com If you don’t understand value investing in 5 minutes, you never will. – Ben Graham Simple, but it is a concept which is at the core of value investing and my beliefs as an investor: Buy something for less than it’s worth. The difficulty resides, of course, in determining how much something is worth. For that you will need several tools, and you will need to think in a way most people don’t. As such, being a value investor doesn’t apply only to stocks, but to buying groceries, shopping for clothes, and how you choose to spend your time. The eternal question is: Am I getting more than I’m giving? You can’t do the same things others do and expect to outperform. Unconventionality shouldn’t be a goal in itself, but rather a way of thinking. – Howard Marks. This is an oversimplification of the framework within which I have chosen to analyze the markets and securities. Here are my favorite books for anyone who wants to embrace this mentality and view of the world. Howard Marks: The Most Important Thing Seth Klarman: Margin of Safety George Clason: The Richest Man In Babylon George Soros: The Soros Lectures II. Where To Look For Securities? Source: Featurepicks Understanding the framework is one thing, operating within it is when the fun starts. If we group together all securities listed on the NYSE, Nasdaq and TMX Group, there were a total of 9012 as of January 2015. It is unlikely that any of us will ever have time to sift through all of them to find a mispriced gem. As such, we must find places where there might be a structural or emotional reason which justifies a discrepancy between price and value. In a market there must be a buyer for every seller, and a seller for every buyer, and understanding what motivates your counterparty is key. Try to imagine what the person on the other side of the trade was thinking. – Leon Levy It is Seeking Alpha’s contributor Chris Demuth Jr. who first got me to think this way. He takes pride in ” looking for non-economic counterparties “. There are many places one can search to reduce the amount of securities you need to look at to find an opportunity: worst performing stocks on any given daily session, spinoffs, mergers, upcoming inclusions or recent exclusion of major indices, articles in Wall Street Journal or Barrons (If you are going to subscribe make sure you get a discount, and once the discount is up call them to cancel, they will give you another), people you talk to, and authors on Seeking Alpha. You want to be looking in places where any of these apply: Your counterparty is panicking, and you can provide the liquidity they need at the price you want. Your counterparty isn’t looking, maybe there is no or little Wall Street/Bay Street coverage? Your counterparty doesn’t have a choice, like an S&P 500 ETF (NYSEARCA: SPY ) having to sell all of their position in the 500th stock when it becomes the 501st largest stock. Or like dividend funds having to sell their position when a company cuts the dividend, or spins off a division. What gets us into trouble is not what we don’t know. It’s what we know for sure that just ain’t so. – Mark Twain Flip the question, what does your counterparty know, that just ain’t so? There are three books I would recommend you read to help you find the best people to buy and sell from. Joel Greenblatt: You Can Be A Stock Market Genius Leon Levy: The Mind Of Wall Street Ken Fisher: The Only Three Questions That Still Matter Immature poets imitate; mature poets steal. – T.S. Eliot Here on Seeking Alpha, we are lucky enough to have among us some great minds. Sift through different authors, find authors who have a style you like. Think for yourself, but feel free to steal ideas, trust me the stocks don’t care whether your hard work found the opportunity or someone else’s did. These are my 3 favorite authors, but based on your style, there are many others which can offer you what you need. In no particular order: Also, look up value funds in your town. Send them an email, have a chat, ask questions, build relationships. Motivate your friends into learning more about investing, you’ll be doing them a favor. Everyone you know with a common interest in investing might have a great idea for you. III. How To Analyze The Stocks You Find? Source: Crossfitinvasion Once you have found a security with a reason to justify its mispricing, you will want to figure out what is the company worth. As an investor you will come to look at stocks as companies, not as lottery tickets. In doing so you will have to analyze companies’ business models and industries. It might seem like a daunting task and you might not have access to professional industry reports (I don’t), but a few quick searches on Google will help you gain the insights you need. Warren Buffett says he looks for companies which have large moats around them, companies whose returns on invested capital remains above their cost of capital for a long period of time. You will also want to analyze the management and strategy of the companies. To help you understand great business models and great management, there are two books which I recommend: Michael Porter: Competitive Advantage Mckinsey: Value, The Four Cornerstones of Corporate Finance. You will gain many insights from reading biography type books of successful investors. Time Horizon is a framework for patience. The two are almost the same thing but the first helps with the second. Knowledge and time horizon team up so you can more easily be patient. – Frederick Kobrick I enjoyed these: Peter Lynch: Beating the Street Mark Stevens: King Icahn Frederick Kobrick: The Big Money Peter Cundill: There’s Always Something To Do Obviously you will need to have a working knowledge of corporate finance, accounting principles, and valuation models. I use comparable ratio analysis as a guide to how a company fares against the competition. I will question any discrepancies in multiples within an industry to understand why some companies command higher relative prices than others. There usually is a good reason. I will also perform a DCF valuation of stocks I analyze. My thoughts on such models are mixed, since the output is only function of the inputs. Bullsh*t in, Bullsh*t out. When I talked to Natcan’s previous CEO Pascal Duquette, he told me of a time when he had to value an oil rig which was privately owned by a fund he worked for during his career. He had all the information, from the number of workers, to the amount of planned production. After just two years, his previsions of earnings were off 25% because one input hadn’t been correctly modeled. On the other hand a business’s value is equal to the present value of the future cashflows the business will generate, so you can’t ignore the model. The way I proceed is by reverse engineering the DCF. Assuming constant margins, what revenue growth is required to justify today’s price? Is such growth attainable? If not, what kind of margin improvement will be necessary at a lower growth rate to justify today’s price? Once again, is it achievable? From there I’ll use my judgment, are the assumptions priced into the security underestimating its potential, or overestimating it? By how much? Are they being underestimated enough that even if my conservative estimate is off, the security is still mispriced? Thinking as an investor, means creating a distribution of potential outcomes in your mind. If X, Y or Z happens, what does it mean for the price of the security? How likely are X Y or Z? What is the weighted value of the security for these given outcomes? It is an approximate exercise, but it’s the best we have. It’s what Howard Marks would call “second level thinking”. IV. How Many Securities Should You Buy? Source: icollector Now we come to portfolio allocation. I have to say, I’m unimpressed by Markowitz’s portfolio theory, and most of modern finance’s theory of investing. They teach us how markets should be, not how they really are. The single reason ultimate diversification doesn’t work, is that in times of crisis, correlations go to one, and you lose as much money as everyone else. As for eliminating firm specific risk, the consequence is also eliminating firm specific return. Risk doesn’t lie in the volatility of returns, but comes from the operations of the companies in which you invest in, and the price you paid for those companies. So how many stocks should you buy? It depends. It depends on your goals, on your aversion to losing money. I have met with the money managers from different firms, here are a few who have different outlooks: Brian Pinchuk from Lorne Steinberg Wealth Management , this value firm believes in investing no more than 3% of the portfolio in an individual security. Patrick Theniere, from Barrage Capital who believes in concentrated portfolios with stocks taking up as much as 10-15% of the portfolio. Paul Beattie from BT Global Growth , who has a couple dozen positions long and short. All three are successful money managers and have good track records, so there is no one size fits all answer. On one hand, if you have a stock go up 50% when it is only 1% of your portfolio, it will only represent a .5% gain for your portfolio, on the other hand a 50% loss on a 10% position is a 5% loss for your portfolio. I believe Ken Fisher summed it up when he said: Don’t aim to beat your benchmark by more than you are comfortable lagging it. No matter how many stocks you choose to buy, give yourself the chance to initially be wrong on the price you pay to double down several times to reduce your price. I adhere to Chris Demuth’s outlook on portfolio sizing which you can read more about here . V. Measuring Your Performance. Source: Rowealth You will also choose how to measure your performance. Are you aiming for absolute performance, or to beat a benchmark? Even if your goal is absolute performance, you will be confronted to comparing yourself to the benchmark. Why? Because if after several years you are unable to do better than an appropriate benchmark, why not spare all the effort and just invest in an ETF? You have to admit, over a long period of time it seems like a decent idea. SPY data by YCharts On the other hand I smirk every time I read a fund manager says he is happy because this year he delivered a performance of -10% whereas the S&P 500 did -20%. Yes it seems tough to deliver absolute returns during bad years for the markets, and I don’t claim to be able to do so, time will tell. Ultimately I’m seeking to perform on an absolute basis, as should all individual investors who are investing with the goal of spending that money someday. The problem with trying to beat the market is that many money managers have become closet indexers during the years. The question for these people is no longer: Do I want to own Apple (NASDAQ: AAPL ) or not at these prices? The question becomes: Should I overweight or underweight Apple relative to its weighting in the index? For me, this just isn’t intelligent investing. VI. Don’t Be Afraid To Share Your Ideas. Source: Wordpress Once you start to analyze stocks and find ones you would like to own, why not share your ideas on Seeking Alpha? One thing we all have in common here, from contributors, to readers, is we want to find great stocks for our portfolio. Writing articles here will help you put your ideas on pen and paper, the editorial team will help you go further on parts of your analysis you might have overlooked, and confronting comments will help you think of your thesis in a different way. Like everyone you are going to have some dogs in your portfolio, and it will be easy for you to blame it on the market or on bad management or whatever, but having your bad picks publicly available on Seeking Alpha will force you to question where you went wrong. I for example, recommended buying Volkswagen earlier this year. Not so great looking back, and rather than just shrug it off, I’ve learned that I should be weary of companies with obscure corporate structures since it creates opportunities for management to employ devious practices. VII. Final Words. I look forward to everyone’s comments, please feel free to confront me on anything you disagree with, constructive criticism is always welcome. If you liked this article, please consider following me on Seeking Alpha. Also in this article I gave a list of my favorite books. The price of these books quickly adds up. My tip to saving money on books was buying a kindle reader. You can get their latest tablet for $50. Kindle books are usually a bit cheaper, but subscribing to Scribd was my favorite way of reading all these books cheaply. I have no business with them but the subscription costs $10 a month, and if you use this link you’ll get two months free (No I’m not getting compensated for this.)