Some thoughts part 2

2. The never ending debate between concentration and diversification:

in my investing years so far, I have read several books, heard several speakers, read various articles, blogs, subscribed to newsletters etc only to learn each individual has his own style. It’s the comfort of what works for you that sets in to usually guide you on what you should do. However why I am personally in favor of diversification is-

a) a concentrated investor usually owns a handful of stocks bought at a certain price. Since traditional teaching tells us you need to buy right and sit tight, and stock prices the,selves never sit, it usually follows that post a stock,price rise, a concentrated investor never buys more and thus keeps adding cash waiting either for a fall or opportunity. I assume this can’t go on forever in terms of opportunity to add another company as if it were then by sheer addition itself there would be diversification. A cinventrated investor thus is not fully invested and chooses to hold lots of cash. Imagine if you were concentrated and owned 60 pct equity that does well and 40’percent cash.

the market does well and your 60 percent invested say goes up 50’percent. The rest 40 percent in a saving account or fixed deposit goes up say 6 pct post tax. Your total,portfolio returns then are 56 pct, which is phenomenal. However if instead of earning 6 percent you owned more stocks having bought other good ideas or seemingly good ideas and because of a rising market made say a lesser than your top bets return of say 25 percent (half) would your overall portfolio returns not rise??

In other words, what counts is absolute money made. To ignore the 40’pct computation in assessing how well the rest did is itself a falacy.

Buffett himself talks on this. He says you are playing baseball and someone keeps throwing pitches at you. By pitches he draws an analogy to stock prices. Some days the pitches are high and you do nothing. Other days they are low and you swing and hope to get a home run. In a diversified portfolio you are an allocator of capital based on the availability of cash, the concept of limited resources (cash) being capable of put to alternate resources (opportunity cost) and a stock market which more than ever before gives you so many opportunities. Why i say more thnk before is:

Globalization has been a game changer. We have a market with heavy fii influence and an extra ordinary media coverage on companies literally by the minute. In such an environement even an issue with a fund in one part of the world triggers a reaction within india. A problem with a co that just beats street expectations and put up its best result puts a pressure of more build up vs sustainance of delivery buying vs it’s now in the price reaction triggering the price to fall. A black swan in the company or elsewhere causes nervous prices. And how!! China, Greece, interest rate fears in usa, quantatative easing, npa in a bank that has lend to a company that is troubled and its impact collectively on interest rates, crude, commodity crackdown or rise, forex issues etc….the list never ceases to end.

Thus stocks are far more volatile than before. Which also means they throw more opportunities than before. Usually not limited to where you concentrate but everywhere. You are not beating your best bets when you buy new you are beating your cash returns.

I will also clarify- when I buy where I see opportunity I won’t necessarily sell just because it has gone up. I will sell only if my cash has better use. And if I can get a 30/40 pct vs a 6 pct I’m good.

Markets also fall. They always do. and when they do it cascades into almost everything falling. Why? Cause when someone makes a loss on something his psychology tells him to make good the loss by booking profits elsewhere before they disappear. This update is not intended to capture if that is right or wrong but that’s the usual behavior norm.

When stocks fall I have always got a sense of where I want to build up vs where I would like to encash. The reluctance to deploy cash is usually met with a switch over strength and what I liked more than others is now within a better “buying power”. As long as one day before my returns on non core are beating cash in bank, I’m good.

my own journey also benefits from another buffett thought: keep cash flows coming. The word is flows not stagnation. They May come by stock appreciation of non core and your beating the banks or by other sources of income ( I work and hopefully hard enough) or other sources like rental incomes or dividends etc.

Hope to update the next line of thoughts in a few days.

Happy investing and happy learnings. Feedbacks welcome as always.

There are no stock disclosures in is write up. But for the sake of good processes, I am passionate on what I do including investing. And not a registered sebi analyst. One thought of action may not be conducive to a completely different set of circumstances and like I said earlier, success has infinite molds.

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7 thoughts on “Some thoughts part 2

  1. Naveen says:

    Thanks for this article. I always thought diversification is the best approach. But couldn’t figure out the right portfolio size, probably there isn’t one.

    Also is investing in MFs (again diversified classrs) akin to parking cash in bank instruments? The returns from my stock portfolio over the period of last two years is 30% more than the returns I’ve got from MFs. My MF portfolio returned not more than bank FD rates in this period.

    So far I’ve maintained a ratio of 75-25 for my Stocks and MFs respectively. But always am tempted to increase the allocation to Stocks.

  2. sarvdeep123 says:

    Hi,

    Thanks for sharing your view on diversification v/s concentration of portfolio. I also have read a few books but not as many as you do ;-). My favorite books on this question are The Dhando Investor & The Thoughtful Investor. Both of the books somehow urge the investor to concentrate on their investment. What I could understand by means of diversification is that it protects us from bad investments outcome. Investing is game of odds and if the odds are heavily in your favor one should not diversify more instead bet heavily!!. Also buffett talks about taking 20 investment bets in your life time by which he means that select your investments very carefully and this way the person will limit his investments where he is sure of 90% & more.
    A person who has just started out should diversify more since beginners make mistakes no matter how confident they are. Also while diversifying he should cut his loses instead of booking his profits in which he was right. While all the experienced investors usually have a concentrated portfolio since they have been on the field from long time and understand all the pitches.
    Even though they are experienced but they too design their portfolio in such a way that a -ve black swan doesn’t hurt them!!

    “Thus stocks are far more volatile than before. Which also means they throw more opportunities than before”
    I just loved this sentence in your post. New people like me are worried that in today’s world of information where all the companies are being covered by professional analysts, how can a retail investor make money. I think this clarifies the -ve thoughts.

    Regards,

    Sarvdeep Malhan

  3. Pradeep says:

    Hi, what about diversification go wrong!. if we invest 40% also and it reduced to 10% because of our wrong decisions because of too many decisions.. As buffett says, if we make less decisions, we will get more time to think and rethink about our decisions to reduce errors and vise versa.

  4. safirpicks says:

    Hi. It’s true that scrips can go wrong, I’m not even advocating what you should do. I just shared my learning. What makes you think you have quoted buffett as concentrated when he owns over 100 cos. For someone keen to invest only 40 percent one can chose a more concentrated holding as that’s exactly what I wrote, if a person invests 40 percent to see it go down to 10 percent and not recoup to give good gains, he is a bad investor. It won’t matter what he owns of his stocks on a diversified basis can fall 75 percent.

  5. Pradeep says:

    Yes! it is purely on ones personal capacity and experience how many right decisions one can make and succeed. I agree that if someone did not recoup their bad decisions, he is a failure but for the sake of diversification/cash holdings, taking a bad decision and recoup from it is also a bad idea except he might learn something from it.
    I am just putting a counter argument which came in my mind to juice more from you:)

  6. GD says:

    please share your top five favorite books on investing…

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