Wednesday, May 07, 2003 2:15:02 PM
Hi Steve,
I believe this because I think:
1) We should always be looking at a company's fundamentals (balance sheet, income statment, cash flow statement) to ensure they stay at a place where we're still comfortable with them. If there's another company that has a high positive correlation with one we currently hold, but its fundamentals become better at some point, then that's the company we should be in -- not the one we may currently hold. This means that owning more than 10 stocks will usually require too much time to keep track of them all. Rather we might only be able to give them cursory glances.
2) Portfolios can be sufficiently diversified over a few industries that have lower positive (or negative) correlations between them. We don't need to buy a stock (or stocks) in *every* industry (in fact many of these industries are highly correlated anyways).
3) We should be investing in only the best companies after we've done our homework. Every day we should think, if we had this amount of money in Cash (rather than stocks) and we had to purchase stocks today, would we choose the ones we have now? Or would we choose others? If we have too many stocks, we can't answer these questions in a reasonable amount of time.
4) We should be viewing our entire financial situation when it comes to diversification. We shouldn't look at our stocks in isolation. So if we own a house, a rental property, other assets and such, we are already diversifying over different asset classes and are lowering our risk. So we can afford to choose slightly riskier stocks. If all of our assets are in stocks, then we'd better choose good lower-risk ones -- but we should still be able to diversify sufficiently with 10 or less well chosen stocks. On this point I believe that as our portfolios grow significantly, we should be pulling out some funds periodically and investing in other asset classes (such as rental properties, etc.)
5) The reason most investors think they should have more than 10 stocks is because that's what the mutual fund companies do and advertise as the correct way to diversify. Since most investors don't know how to diversify correctly, they simply buy into that argument. But mutual fund companies have Billions and Billions to invest. So there is no way they can limit themselves to 10 or less stocks without affecting the market for those stocks. Therefore they need to invest in lesser quality offerings in order to fulfill their mandate. However individual investors don't need to do this (unless they have Billions and Billions to invest -- in which case I'm guessing they already know what they should be doing
because they cannot affect the market for widely traded stocks. Therefore they can invest in the cream of the crop.
6) We're investing, not trading. Therefore 10% of our portfolio in a stock is okay. If we were trading, we'd probably only want about 2% (or less) of our portfolio in any one position.
7) If we have to buy/sell a significant number of stocks (to rebalance, switch, or whatever), trading costs can increase and the time required to manage this increases.
(One other note, I'm talking about our main *investment* portfolio. I think it's also good to have a little money set aside for short-term trading strategies -- in which case you might own more than 10 stocks, but only for short periods of time. However the vast majority of people will do better investing for the long-term rather than trading and I view trading as a higher-risk activity that isn't suitable for many investors.)
I believe this because I think:
1) We should always be looking at a company's fundamentals (balance sheet, income statment, cash flow statement) to ensure they stay at a place where we're still comfortable with them. If there's another company that has a high positive correlation with one we currently hold, but its fundamentals become better at some point, then that's the company we should be in -- not the one we may currently hold. This means that owning more than 10 stocks will usually require too much time to keep track of them all. Rather we might only be able to give them cursory glances.
2) Portfolios can be sufficiently diversified over a few industries that have lower positive (or negative) correlations between them. We don't need to buy a stock (or stocks) in *every* industry (in fact many of these industries are highly correlated anyways).
3) We should be investing in only the best companies after we've done our homework. Every day we should think, if we had this amount of money in Cash (rather than stocks) and we had to purchase stocks today, would we choose the ones we have now? Or would we choose others? If we have too many stocks, we can't answer these questions in a reasonable amount of time.
4) We should be viewing our entire financial situation when it comes to diversification. We shouldn't look at our stocks in isolation. So if we own a house, a rental property, other assets and such, we are already diversifying over different asset classes and are lowering our risk. So we can afford to choose slightly riskier stocks. If all of our assets are in stocks, then we'd better choose good lower-risk ones -- but we should still be able to diversify sufficiently with 10 or less well chosen stocks. On this point I believe that as our portfolios grow significantly, we should be pulling out some funds periodically and investing in other asset classes (such as rental properties, etc.)
5) The reason most investors think they should have more than 10 stocks is because that's what the mutual fund companies do and advertise as the correct way to diversify. Since most investors don't know how to diversify correctly, they simply buy into that argument. But mutual fund companies have Billions and Billions to invest. So there is no way they can limit themselves to 10 or less stocks without affecting the market for those stocks. Therefore they need to invest in lesser quality offerings in order to fulfill their mandate. However individual investors don't need to do this (unless they have Billions and Billions to invest -- in which case I'm guessing they already know what they should be doing
because they cannot affect the market for widely traded stocks. Therefore they can invest in the cream of the crop. 6) We're investing, not trading. Therefore 10% of our portfolio in a stock is okay. If we were trading, we'd probably only want about 2% (or less) of our portfolio in any one position.
7) If we have to buy/sell a significant number of stocks (to rebalance, switch, or whatever), trading costs can increase and the time required to manage this increases.
(One other note, I'm talking about our main *investment* portfolio. I think it's also good to have a little money set aside for short-term trading strategies -- in which case you might own more than 10 stocks, but only for short periods of time. However the vast majority of people will do better investing for the long-term rather than trading and I view trading as a higher-risk activity that isn't suitable for many investors.)
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