Whether to have a Concentrated or Diversified Investment Portfolio

I just read Kyith’s recent post titled “Having Enough Humility in Investing & Managing Wealth” (read here).

In it, he mentioned about having a concentrated portfolio vs a diversified portfolio. Concentrating in our portfolio is safer if we have the investment sophistication to do deep research on investments well. The question is really if we have the investment sophistication to do deep research.

Recently someone reached out to me and asked me why I stopped posting articles about Sarine Technologies, and he was thankful for my previous blog posts pertaining to that company. He himself is heavily invested in Sarine Tech, but is currently having a big unrealised loss (to the tune that the amount is big enough to buy a car). He believes in doing deep research and having a concentrated stock portfolio.

The different stages

I know what I say would not change anyone’s thinking, and I am not trying to. I don’t claim to be an expert and I don’t think I am. Nevertheless, perhaps let me share my thoughts.

I think at different stage of our life we do think differently. Our thinking evolved over time, so to speak. Two key factors are in flux. One is your overall net worth and the other is the runway you have left to have a full time job and earn active income (without really a need to dig into your passive income / investments).

To quote Kyith:

“Your net worth is $50,000 and your annual savings from work is $25,000 a year. You can sink $50,000 into 2 stocks. If you lack sophistication and one of them blows up and left you with $30,000, it is not a catastrophe. In a year’s time, you have new capital coming in. You can learn from this experience and get better.

Now, let us say the same advice is given to someone with a net worth of $1 million. Her future capital injection is $150,000 a year but she is scheduled to stop work in 1 years time. If the same thing happens and her portfolio is left with $600,000, how would she feel? It is likely to affect her quite a fair bit.”

When we are in our 20s or 30s, with our limited budget, it does not appear that rewarding holding a basket of stocks (probably slow growers / late stage dividend stocks), earning 3% to 4% annual yield. Heck, even a mixture of growth and dividend stocks would pale in comparison when we think about the growth potential of a concentrated portfolio of a few super high growth speculative stocks.

At that time, we may have to worry about paying off our student loans, mortgages, childcare expenses, setting a sum aside for our parents’ allowances etc… a budget of say $10,000 will just yield $300 to $400 annually assuming a 3% or 4% dividend yield (divide by 12, that is only $25 per month), and assuming we have no capital losses. In addition, when our budget is small, it is really hard to buy individual stocks (heck, for some stocks, the min. lot costs more than $10,000). There might be a better chance in achieving a better result, if we aim for and focus our limited budget on fast growing (non dividend paying) growth / speculative stocks.

I totally get it.. I have been there, done that. When I first started investing, ETF or Index funds were not that prevalent. Back then, unit trusts were more common, and the fees was always a factor to note. And yes, it was not easy to buy individual stocks with my limited budget and the strategy of building a dividend income wasn’t that attractive when my invested amount is small.

On the other hand, when the budget is more than $500,000, with much less runway left, management of the portfolio or portfolio allocation becomes increasing important. And with more experience in investing, and after being through a number of market corrections and crashes, we may tend to be more defensive in our thinking. A small percentage drop to that amount would also mean a bigger absolute amount. After all, we may not have that many opportunities to make back what we have lost (unlike the younger you). However, suddenly that 3% to 4% annual dividend yield does not seem that little. A budget of say $500,000 will yield $15,000 to $20,000 annually assuming a 3% or 4% dividend yield (divide by 12, that is min. $1,250 per month),

To quote from the movie Pacific Rim: “There are things you can’t fight, acts of God. You see a hurricane coming, you have to get out of the way. But when you’re in a Jaeger, suddenly, you can fight the hurricane. You can win.”

On another note, eh yes, either you win big or lose big (if you have a concentrated portfolio).

At some point of time, I have very concentrated positions in some stocks. Some did well, and some didn’t. There was always no problem when things go my way. The issue arises, when the tide goes against me. Or how Kyith puts it (when having a concentrated portfolio)- if one blows up.

For me, the ones that did crashed spectacularly in my then concentrated portfolio are Golden Agri and Sarine Technologies. For the former, I can totally attribute it to the lack of experience in my younger years and listening to my parents (who are also not experts in stock investing). For the latter, at one time, Sarine Tech was a high flying growth stock – I did read up on it, but perhaps I was too complacent. Fundamentally, it was not a terrible stock, but the industry changed (and many other factors). By the way, the stock price run-up of Sarine Tech has been amazing in recent days and weeks.

All I can say is, luckily I wasn’t too concentrated in those 2, and I live to invest another day.

The stock market always have a way of humbling us.

“I’ll never put my life savings into a single investment that could go to the moon. But being a diversified investor means I’ll never put my family in the position of being completely wiped out by a single position.” Ben Carlson, portfolio manager at Ritholtz Wealth Management LLC (read here)

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I once heard someone mentioned that in history there is no ‘IF’. We can look back at history with 100% certainty. If only investing is that easy. The thing is, we all know that the stock market (and any individual stock) is forward looking. So, there is a BIG ‘IF” when we think about any stocks. It is always at the back of my mind.

Some people say stock investing is akin to ‘Informed Gambling”. No doubt there is always an element of luck (or lack of it) when it comes to stock investing – nothing is certain.

Doing Deep Research

I am sure many investors would agree that it is important to know what we own. We all read what Peter Lynch, Warren Buffett and Charlie Munger said.

However, I am sure many people do not really know much about the stocks (or the companies behind the stocks) they own. In many of the articles and books I read, in the surveys, many people highlighted that did not read the annual reports / quarterly reports of the companies they invested in (for various reasons – no time, not interested, don’t understand….). Many of us hold full time jobs and our jobs don’t entail doing research on companies. Investing is like a part time job for us.

So unless you are in the management team of the company you are invested in, or have spent many hours researching…. very few of us can say we have an edge.

More evidence that few read annual reports (read here)

We all know that Warren Buffett, in his early days, was heavily influenced by Benjamin Graham’s thoughts and methods of value investing – the so called ‘cigar butt’ investing. At that time, information was not readily available to the general public, and was probably only accessible to a few fund managers. Even then they have to request and wait for a copy of the annual report to be mailed to them. To read up on the financial data of a company would probably entail going through stacks of the Moody’s manuals in the library. Yes that was the Warren Buffett and Peter Lynch’s era.

At that time, it was possible for them to have an ‘information’ edge if they put in the effort.

Over the past 2 to 3 decades, with the rise of the internet, information is readily available. Perhaps too much information. We are constantly faced with an onslaught of information. We can now screen though the long list of publicly listed companies via a few clicks of the mouse. We can set the parameters for companies with the best track records, best balance sheets, etc…. and viola, shortlisted stocks / companies will appear on the screen.

So much so that having an edge (in readily available information) is starting to become a myth. In terms of financial data, finding hidden good companies is not that difficult (unlike in the 70s to 90s).

Then there is another school of thought highlighted by Monish Prabai. Doing deep stock research could adversely influence our thought processes, and yes impact our financial health. We are all prone to mental biases unconsciously. When we spend too much time reading and thinking about any particular company, it kinds of get drummed into our mind (like how worshippers kept reciting phrases in the Bible or the Quran), and blinds us from the flaws. And the worst part is – we may not be aware of it.

Doing deep research will not move stock prices. However, it can prevent us from making rash moves or uninformed decisions. Or as mentioned by Monish Prabai, it can adversely influence us.

Knowing the numbers will not make me an Alpha investor, but it can minimise downside risks. At least I know I am not investing in a fundamentally bad company. However, I also know I cannot influence the narratives, the future and there is always a BIG ‘IF’. What if the narrative change; what if the whole economy changed. Before 2020, very few would have imagined the impact of Covid-19… well I didn’t imagine the extend of the impact would be as it is. However, there is always a possibility.

Having said that, on the other hand, it also does not mean that one should not do any research at all prior to investing or just blindly entrusting his/her hard earned money to others to invest (or how Kyith puts it – having too much humility). We still need to do our due diligence.

Without taking the effort to be informed, it is not even “Informed gambling”, it is just gambling.

In gist, ask ourselves if we have read the financial data, annual reports or quarterly reports of the companies prior to investing or was it based on some random YouTube or Tik Tok videos talking about the quick rise in its stock prices.

What is your Edge?

Many times, I have to remind myself that psychology plays a big part in investing. I have to be mindful of anchoring bias, endowment effects, fast vs slow thoughts (2nd level of thinking) etc.

As mentioned by Peter Lynch, the stock does not know that you own it and neither does it care. As small time passive retail investors, we don’t influence the stock prices. Beyond the IPO stage, movements in stock prices don’t really influence the company performance as much, unless the company is seeking to raise capital via issuance of equity, etc. We are price takers, not price movers. We are not big time activist investors like Carl Icahn or Bill Ackman, who holds key or majority stakes in the companies.

When I read about how some long time investors mentioned the reasons they invested in Tesla was to support Elon Musk .. I was scratching my head and trying to comprehend how is it so. Perhaps their stake (shareholdings) is really very very big (or well, at least they are not shorting the stock).

For myself, the question will always be what edge can I offer here, prior to investing? Since investing is technically a zero sum game. What makes me think I have an edge over people who are selling when I am buying (and vice versa). After all, I read the same news as you guys (maybe some from different sources), and at about the same time.

For me, I can humbly say that I do not have much technical edge, and I cannot influence stock prices. However, there are general principles which will always be important… the importance of thinking unbiasedly and considering a while range of information. So yes reading broadly and from different points of views is important. To not just act on impulse and slow down to consider. Perhaps I may be able to see things from a different angle while reading more. Lastly execute if odds are in my favour, but acknowledge that I can still be wrong.

Or to put it in another way, think of how Peter Lynch / Howard Marks would put it… People study many years and then practise many years to become a professional in their job eg. a doctor, a lawyer, etc. However, many people think that they can become professional stock investors (or fund managers) in a very short time without putting in much time and effort. They can somehow pick a few stocks and these will just be multi-baggers after a while. Yes, Warren Buffett and Charlie Munger advocates holding concentrated portfolios, but how many of us can really say we are on par with them?

More often than now, I will have to wait for the market to instruct me on my next move.

Howard Marks likes to view investing as playing with odds. Yes, there is no certainty in investing. However, at times, the odds are in our favours (and at other times, they are not). Even if the odds are in our favour, we may not always win (and vice versa). We can be so right in the odds, but still fail eg. end up picking up a red ball from a bag with more black balls than red balls.

There is really no right or wrong. Even if I made 5 or 6 times my investment, there will always be ‘what’s next’. Will my investment thesis be always the same (provided that I have one to start with in the first place)? Will I be lucky every time?

We can really spend a lot of time thinking about what will move stock prices and the stock market in general. However, often it is beyond our comprehension.

I came across the concept of the Keynesian Beauty Contest, and how the stock market is like it. Short term price volatilities can be attributed to the assumption of what most investors think others are doing. Headache……!

Keynes’s ‘beauty contest’ (read here)

To quote the above article: “Instead, Keynes thought that professional money managers were playing an intricate guessing game. He likened it to a common newspaper game “in which the competitors have to pick out the six prettiest faces from 100 photographs, the prize being awarded to the competitor whose choice most nearly corresponds to the average preferences of the competitors as a whole: so that each competitor has to pick, not those faces that he himself finds prettiest, but those that he thinks likeliest to catch the fancy of the other competitors, all of whom are looking at the problem from the same point of view . . . We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practise the fourth, fifth, and higher degrees.”

Is the Stock Market Really Just a Beauty Contest? (read here)

The influence of online (Social) Media

In the past, the media (or in general, news) was more straight-forward. We have the major sources of news from major news vendor. Most people get their daily dose of news from the mainstream TV network or hardcopy newspapers.

However, these days, we consume information from many sources. And we fear fake news.

The rise of social media in the past few decades has been unprecedented. In the video above, Joseph Carlson, mentioned that there are increasing videos in Tik Tok from people stating how easy it is to make money in the stock market (without much details), with one stating how she made $4,000 from $1 via trading.

Many of these videos are from unqualified influencers advocating being concentrated in speculative stocks to reach specular results, and these are watched by millions… and we can be sure that out of these millions, some of the people who have watched these videos will be influenced by them (and act on these ideas).

People like to search for Get Rich Quick videos or articles. After all, it is not as sexy as building wealth via the slow painful way of investing in diversified stock portfolio of fundamentally strong companies.

After all, we have countless examples of the so called people with ‘dumb money’ becoming instant millionaires. Who is anyone to say they are wrong?

In addition, when we think about the social media, there are always algorithms that direct more of similar content to users based on what they have searched for (or have watched before). In short, the media on the internet gives us what we want to consume. We are now the products.

In summary

I don’t think I am in any position to say if anyone’s method is right or wrong. However, I would need to think if their strategy suit me currently and I would think twice before acting on what I have watched or read on the internet.

If we intend to have a concentrated stock portfolio, we need to really ask ourselves if we had done our due diligence in doing deep research, considering all unbias factors and if we indeed have an edge.

Also, if we are ready for the risks involved.

Otherwise, it be be a better strategy to have a more diversified portfolio made of fundamentally strong companies. Or having different asset classes.

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About apenquotes

Born in 1976. Married with 2 kids (a boy and a girl). A typical Singaporean living in a 4 room HDB flat. Check out my Facebook Page: https://www.facebook.com/apenquotes.tte.9?ref=bookmarks
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