How many Stocks should you own?
Congratulations! You have decided to begin your investment journey! Now what? What do I buy? How do I do it? And how much?
For this months investment outlook, I’ll introduce you to a framework to help you understand how to invest and take advantage of all the options at your disposal.
It helps to be informed and to know as much about the investing business as possible — if for no other reason than to know all the things you should avoid. Don’t have a financial advisor make it too complicated; keep it simple.
How Many Stocks Should You Really Own?
How many times have you been told, “Don’t put all your eggs in one basket”? On the surface, this sounds like good advice, but my experience is that a non-diversified portfolio performs better than a diversified portfolio.
Worth noting: It’s not just my experience, its math. The average return of 2 stocks, will have a higher probability of being larger than the average return 10 stocks. It’s also easier to manage the risk of 2 stocks, rather than 10.
Why it matters: The more you diversify, the less you know about any one area. Many investors over diversify. The more stocks you own, the slower you may be to react and take selling action to raise sufficient cash when a serious bear market begins, because of a false sense of security. When major market tops occur, you should sell, get off margin if you use borrowed money, and raise at least some cash. Otherwise, you’ll give back most of your gains.
Between the lines: The winning investor’s objective should be to have one or two big winners rather than dozens of very small profits.
- It’s much better to have a number of small losses and a few very big profits. Broad diversification is plainly and simply often a hedge for ignorance. Did all the banks from 1997 to 2007 that bought packages containing 5,000 widely diversified different real estate loans that had the implied backing of the government and were labeled triple A protect and grow their investments? No, they went bankrupt.
The bottom line: Keep things manageable. The more stocks you own, the harder it is to keep track of all of them. Even investors with portfolios of more than a million dollars need not own more than six or seven well-selected securities. The big money is made by concentration, provided you use sound buy and sell rules along with realistic general market rules. And there certainly is no rule that says that a 50-stock portfolio can’t go down 50% or more
Success Tip: How to Spread Your Purchases over Time
The big picture: It’s possible to spread out your purchases over a period of time. This is the best form of diversifying.
When William O’neal accumulated a position in Amgen in 1990 and 1991, he bought on numerous days. He spread out the buying and made
add-on buys only when there was a significant gain on earlier buys. If the market price was 20 points over his average cost and a new buy point occurred off a proper base, he bought more, but he made sure not to run his average cost up by buying more than a limited or moderate addition.
In a bull market: one way to maneuver your portfolio toward more
concentrated positions is to follow up your initial buy and make one or two smaller additional buys in stocks as soon as they have advanced 2% to 3% above your initial buy. However, don’t allow yourself to keep chasing a stock once it’s extended too far past a correct buy point. This will also spare you the frustration of owning a stock that goes a lot higher but isn’t doing your portfolio much good because you own fewer shares of it than you do of your other, less-successful issues. At the same time, sell and eliminate stocks that start to show losses before they become big losses.
Using this follow-up purchasing procedure should keep more of your money in just a few of your best stock investments. No system is perfect, but this one is more realistic than a haphazardly diversified portfolio and has a better chance of achieving important results.
Always Invest for the Long Haul?
What’s critical is buying the right stock — the very best stock — at
precisely the right time, then selling it whenever the market or your various sell rules tell you it’s time to sell. The time between your buy and your sell could be either short or long. Let your rules and the market decide which one it is. If you do this, some of your winners will be held for three months, some for six months, and a few for one, two, or three years or more. Most of your losers will be held for much shorter periods, normally between a few weeks and three months. No well-run portfolio should ever, ever have losses carried for six months or more. Keep your portfolio clean and in sync with the market. Remember, good gardeners always weed the flower patch and prune weak stems.
Key Takeaways
- Diversification is definitely sound; just don’t overdo it.
- Always set a limit on how many stocks you will own, and stick to your rules.
- Always keep your set of rules with you — in a simple notebook, perhaps — when you’re investing. What? You say you’ve been investing without any specific buy or sell rules? What results has that produced for you over the last five or ten years?
