# Diversifying investment portfolio



## jeremykl (9 April 2015)

Does anyone practice portfolio diversification? Is this done through ETFs or individual stocks?

If stocks, how many stocks are required and what process do you undertake to ensure there is diversification?


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## Wysiwyg (9 April 2015)

With regards to stocks, my experience of spreading your money across numerous stocks reduces long term returns due to additional brokerage, reduced dividend yield and reduced winner profits. I hold 1 to 6 stocks that I consider have bright futures plus good dividend yield and I watch them closely. Consider quality rather than quantity.

As far as assets diversification, hopefully others will present some experiences.


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## So_Cynical (9 April 2015)

Wysiwyg said:


> With regards to stocks, my experience of spreading your money across numerous stocks reduces long term returns due to additional brokerage, reduced dividend yield and reduced winner profits.




I hold a lot of stocks across my 3 portfolios (35+) lots of stocks flattens return, due to smaller exposure to outlier winners and losers...that's my experience - real diversification in stocks must also include market/currency diversification.


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## Wysiwyg (9 April 2015)

So_Cynical said:


> I hold a lot of stocks across my 3 portfolios (35+) lots of stocks flattens return, due to smaller exposure to outlier winners and losers...that's my experience - real diversification in stocks must also include market/currency diversification.



The see-saw effect? One up one down.


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## thembi (9 April 2015)

jeremykl said:


> Does anyone practice portfolio diversification? Is this done through ETFs or individual stocks?
> 
> If stocks, how many stocks are required and what process do you undertake to ensure there is diversification?




I have found that ETFs are a fantastic way to diversify portfolios and reduce the risk of 'single stock exposure'. With an ETF such as say QOZ, you can get exposure in one trade to a diversified portfolio of (in that case) 200 stocks. My approach is to use an ETF as a core holding within my share portfolio and then buy some more speculative satellites single stocks where appropriate.

I also use ETFs to diversify my portfolio beyond stocks to include things like small allocations to commodities (such as Gold) or to tilt to sectors that I am currently feeling more confident on (like financials sector at the moment)


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## So_Cynical (9 April 2015)

Wysiwyg said:


> The see-saw effect? One up one down.




Yes - but because there are so many stocks the see-saws are small, also more winners than losers over time but the losers do knock the cream off the top.


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## Triathlete (9 April 2015)

jeremykl said:


> Does anyone practice portfolio diversification? Is this done through ETFs or individual stocks?
> 
> If stocks, how many stocks are required and what process do you undertake to ensure there is diversification?




In my case my trading portfolio would only contain between 5 and 8 stocks 

 Medium / long term portfolio would have between 8 and 12 stocks.

It is all about how you are going to manage your risk factor:

For example if you only have one stock then the specific risk is high. 

Then as you increase your holdings the specific risk decreases and flat lines somewhere between 5 and 12 shares . 

Increasing your the holdings above 12 stocks then exposes the portfolio to market risk which cannot be eliminated by diversification.

If I was just starting out I would be concentrating on big companies say in Top 50 ASX That are fundamentally sound that are rising in price no matter what sector they come from.

Having an understanding of Technical analysis would also help your decision making in my opinion also.


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## Wysiwyg (9 April 2015)

Triathlete said:


> For example if you only have one stock then the specific risk is high.



No it isn't because you position size correctly. For example no more than 20% of total equity in one stock and 1% of total equity at risk. Gap downs aside.


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## Triathlete (10 April 2015)

Wysiwyg said:


> No it isn't because you position size correctly. For example no more than 20% of total equity in one stock and 1% of total equity at risk. Gap downs aside.






I see your point....

But now we are talking about how the  allocation of capital towards your stock picking is distributed in your portfolio.

A different topic all together.


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## jeremykl (13 April 2015)

thanks everyone for your feedback so far.

From my research, I found this study which shows that you need 38 Aussie stocks to achieve a diversified portfolio ...

http://www.utas.edu.au/__data/asset...nd-Tapon-Equity-portfolio-diversification.pdf

On that basis, the cost of achieving true diversification using individual stocks (vs ETFs) becomes very high due to transaction costs. Say $10 per trade (Bells Direct), you are paying $380 just in brokerage. 

On the other side, the management fee of the ETFs (usually around 0.2%, but compounding) needs to be balanced out. 

It seems like the size of the investment portfolio will determine which is the more cost effective method. 

Additionally, we prob need to consider time to manage the portfolio and rebalancing / reinvestment risks as well


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## galumay (13 April 2015)

jeremykl said:


> thanks everyone for your feedback so far.
> 
> From my research, I found this study which shows that you need 38 Aussie stocks to achieve a diversified portfolio ...
> 
> [




Thats just one opinion, you certainly dont NEED 38 companies to have a diversified portfolio. Its a very subjective concept, many different answers will come depending on peoples strategies, investing philosophies and risk management style.

Personally i dont like more than about a dozen companies, it becomes to hard to fully understand the buinesses and follow them intimately if my portfolio gets bigger than that. There is a real danger in diversifying for the sake of it that you add companies that are either too expensive or not good enough quality to your portfolio. 

All of the above is from a fundamental, value investment point of view, no doubt other styles of investors and traders would have a different viewpoint.


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## Value Collector (13 April 2015)

In my opinion it comes down to skill level and the time you put into understanding and following the companies you hold.

If you are a highly knowledgeable investor, that's put in a lot of effort to know your positions, 6 companies would probably be enough diversification.

If you're an unskilled passive investor, you need large diversification, probably an asx200 index is best for you.


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## Value Collector (13 April 2015)

Value Collector said:


> In my opinion it comes down to skill level and the time you put into understanding and following the companies you hold.
> 
> If you are a highly knowledgeable investor, that's put in a lot of effort to know your positions, 6 companies would probably be enough diversification.
> 
> If you're an unskilled passive investor, you need large diversification, probably an asx200 index is best for you.




I just realised I swiped this concept from buffet, I have read and watched so much Buffet stuff, sometimes it's hard to remember whats come from him and what are my own original ideas.


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## luutzu (13 April 2015)

Value Collector said:


> I just realised I swiped this concept from buffet, I have read and watched so much Buffet stuff, sometimes it's hard to remember whats come from him and what are my own original ideas.





haha... best to just accept that you got no original ideas when it comes to investing. I did.

I got a few brilliant moments, pad on the back, well done you genius... then I kept reading Graham and Dodd and damn it. But it's good how investing doesn't pay you to be original, just being able to apply sound business principles.


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## Value Collector (13 April 2015)

luutzu said:


> But it's good how investing doesn't pay you to be original, just being able to apply sound business principles.




Very true.


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## thembi (13 April 2015)

Bottom line on diversification is this.. if you do actually want a diversified portfolio, at a low cost, there is no easier or cheaper way to get it than via an ETF.

As to whether or not you actually want or need diversification however, that is a whole different subject and is up to each individual investor.


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## galumay (13 April 2015)

thembi said:


> Bottom line on diversification is this.. if you do actually want a diversified portfolio, at a low cost, there is no easier or cheaper way to get it than via an ETF.
> 
> As to whether or not you actually want or need diversification however, that is a whole different subject and is up to each individual investor.




You may gain portfolio diversification through an ETF but sacrifice other outcomes. Thats why a balanced approach is required, taking all options into consideration and understanding what the impacts are in all directions. 

I think Buffet's point is well made, if you are happy not trying to beat the index, then ETF's give you both relative performance to an index and internal diversification within the asset class.

If you want to try to beat the indexs and/or have absolute performance benchmarks then diversification is just about the worst thing you can do, but as he says ony a tiny proportion of investors have the discipline and the long term view to be able to achieve such a strategy.


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## jeremykl (14 April 2015)

galumay said:


> Thats just one opinion, you certainly dont NEED 38 companies to have a diversified portfolio. Its a very subjective concept, many different answers will come depending on peoples strategies, investing philosophies and risk management style.
> 
> Personally i dont like more than about a dozen companies, it becomes to hard to fully understand the buinesses and follow them intimately if my portfolio gets bigger than that. There is a real danger in diversifying for the sake of it that you add companies that are either too expensive or not good enough quality to your portfolio.
> 
> All of the above is from a fundamental, value investment point of view, no doubt other styles of investors and traders would have a different viewpoint.




Agree that 38 companies are required to achieve diversification is one opinion - but it sounds about right based on the maths / analysis shown in the research. It is difficult to see how 12 stocks can achieve diversification based on that research. 

I agree that if you own stocks, you should understand them, select them based on quality, valuation, etc. This is very hard to do if you own 38 stocks. 

I'm landing at an understanding that:
+ diversification = exposing yourself you market risk only 
+ an investment strategy that is about diversification is aiming to achieve market returns
+ doing so will sacrifice some alpha (outperformance against the market)
+ if you want a diversified portfolio you should stick to ETFs, stock picking isn't going to work
+ mainly bc you need 38 stocks to achieve diversification, and most people won't have the time (and probably skills) to pick the 38 stocks required
+ you may need more or less than 38 stocks to achieve diversification for the purposes discussed here, but it's likely to be pretty close in terms of number

Actually just thought of something else ... we haven't factored in the cost of implementing the alternative solutions to diversification

a) 38 stocks buy and hold will incur significantly brokerage vs
b) buying into an ETF will have lower brokerage but incur an on-going mgmt fee from ETF manager (compounding)

Maybe this is a major factor in deciding whether ETFs or portfolio of stocks is best in implementing a diversified strategy


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## DeepState (14 April 2015)

jeremykl said:


> I'm landing at an understanding that:
> + diversification = exposing yourself you market risk only
> + an investment strategy that is about diversification is aiming to achieve market returns
> + doing so will sacrifice some alpha (outperformance against the market)
> ...




Just some alternative viewpoints (this stuff is what happens in tightly risk managed hedge fund portfolios):

Diversification is one way to rid yourself of unwanted and/or unrewarded risk.  In many exchanges on ASF, diversification is taken to mean surrender in the face of uncertainty and the acceptance of mediocrity as the less worse outcome.  That would be a fairly serious misjudgment if regarded as a universal statement. 

There can be all sorts of different kinds of risk.  Many of these can be managed via the tool of diversification. There are many other ways (eg. derivatives, stops..).  The most common alternative to diversification as a means to limit your exposure to unwanted risk is usually not to take any exposure in the first place.  The final alternative is just to take it and justify it with a wave to the long term...as if risk managing for the near term is somehow not consistent with getting to the long term with higher probability.

You can build diversified portfolios of stocks that are no where like the market portfolio.

By limiting your exposure to unwanted risks by diversification, you increase your exposure to skill or, otherwise, the part of risk that you want.  For example, if your view is only that iron ore is going up, you would buy an appropriately diversified portfolio of iron ore stocks - or just the iron ore futures.  You have no view on the outlook for individual companies or the value the market is ascribing to it.  In that situation, it doesn't make sense to concentrate your positions in any single stock as you have no particular view on that one stock but you are totally exposed to the events specific to that stock as well as everything else.  All those risks, apart from the anticipated movement in the price associated with iron ore price movements, are completely unrewarded ex ante, in this case.  You have no view, but are taking the risk.

Diversifying does not have to eliminate alpha.  Quite the opposite occurs in sophisticated risk management. By diversifying appropriately, you can actually take pure alpha bets where that alpha is something which spans several companies (eg. like outlook for interest rates or some legislative development).  Building appropriately diversified portfolios will give you a much purer exposure to such concepts.  At the extreme, you will build diversified long/short portfolios to hone in on that alpha.  Also, if your insight happen to be something specific to a company like a new type of super-market format, it may not the best thing you can do just to buy that stock.  It is exposed to lots of other things that have nothing to do with that idea in pure form (per the iron ore example, except there are no futures on the supermarket format available).  The best way to get this idea is to buy the company and sell a diversified portfolio of other companies that otherwise mimic the target as best as possible, except for the bit you want.  That way, the risk you have left is as close as possible to the idea you actually have some notion on.  

Investment is about finding underpriced cash flows.  These cashflows arise from operations of lots of different types.  If your view is targeted, diversification can help you get much closer to that idea than a simple holding in that company.

This is what diversification means to me and people who do this type of stuff.  It is hardly synonymous to throwing up your hands in a cheer for mediocrity. For us, knowing what you actually have as an edge and not doing this to concentrate your risk purposefully into that edge is an exemplar of mediocre practice.  It is about accurately implementing what it is you have a notion on.  For at least some of us lesser mortals, that notion or edge doesn't come in neat packets of single stock like Buffett is presumed to be saying.  

Buffett understands risk. He is very clear on the kind of investment situation that BRK is suitable for. Many/most of the people on ASF would not actually qualify for his original idea of suitable shareholders (which is why the stock never split for ages and became to large a parcel for many less wealthy people).  He goes on and on about Ajit in every report, for example.  Ajit manages risk by diversification and further reinsurance. He is absolutely in the risk business and he cares about it on a on a risk by risk basis (and also gross exposure basis). That's also investment (Selling expected low cashflow relative to premium received) and it is the biggest swing factor in BRK.  Buffett's beef is with over-diversification.  I have no problem with that.  The problem arises when that statement is misconstrued in every context that the word 'diversification' arises in.


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## galumay (14 April 2015)

DeepState said:


> I have no problem with that.  The problem arises when that statement is misconstrued in every context that the word 'diversification' arises in.




Its pretty clear what his view is on portfolio diversification, he states it in simple terms in the linked videos and in other interviews, writings, transcripts etc. 

I think your views on diversification and risk management are interesting, its always informing to read of alternative approaches and differing opinions and your posts always have a very detailed explanation of your opinions and thinking which helps me improve my understanding of the various approaches to these fields.


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## DeepState (14 April 2015)

galumay said:


> Its pretty clear what his view is on portfolio diversification, he states it in simple terms in the linked videos and in other interviews, writings, transcripts etc.




Not specifically making a direct response to you, Galumay...just bouncing off your comments...the below has been on my mind a bit given recent exchanges.  Thought I'd open the floor given the context seems right in this thread.

Here's a good example of his views, I think, given it is him speaking:



Here's a given: you don't get seriously rich by 'dabbling'.  The truly rich take big positions.....*


Question 1:  Listening closely...Under what conditions are highly concentrated positions ('6 businesses' (1:05)), when thought of as a stock level bet, truly appropriate?  How closely are these conditions aligned with those who have extensively espoused the Buffett way as their mantra in all these threads?


Question 2: Who is in line to take over the BRK portfolio when Buffett is gone? 


Question 3: How many stocks do they own?  Presumably, as presumptive heirs to the throne, they are pretty much the very best investors in the world.


Question 4: Of the 'twenty punches' (1:55) in their punch-cards, how many have the presumptive heirs used in their investment careers to date, even before they have assumed the throne, even allowing only for the period after they were called to the clan? 


Question 5: What if, with some humility, your working model is to assume that you might not quite be as good as the presumptive heirs, let alone Buffett.  What does that mean?  If 'maybe more than 99% of investors should extensively diversify' (0:20)  and the best of the best of the best that aren't Buffett hold what they hold with multi billion dollar portfolios....what would that mean for a level of genius that ranked someone at 98% (a level that would get you into Mensa if this were IQ) with more liquidity?


Question 6: Despite having the very best choice of investors available to him and likely in place for his eventual retirement from BRK, how many stocks are in the portfolio that he wants managed for his wife when he is gone? Why would that be if the Buffett/Fisher/Graham approach is so well codified that the accolytes can read books, watch videos etc... that outsized profits should be easily found amongst the legion of followers?  The moment before this death, his wealth is mostly in BRK.  But that is not appropriate for his wife after he is gone??? The polar opposite, actually.  Maybe it isn't quite so straight forward after all?


Question 7: Given there are other pretty good investors in the world, how many stocks does Soros, Dalio, Fink, Marks, Lynch... own or have owned? What about private markets players like Blackstone..the kings of big, concentrated, bets? I'll glance over the algo guys for the minute.  If somewhat more than 6 at a time, or more than 20 in a career, are they not serious investors too whose viewpoints on diversification ought not receive quite a bit of airtime?


Clearly there are many paths to Rome.  However, it does not appear that many of those which are actually being travelled by excellent investors, including the BRK portfolio heirs, point to the literal words of Buffett as oft repeated here and held as absolute truth...at least by some.  That suggests, to me, that diversification beyond ultra concentrated and ultra low turnover portfolios of Buffett-speak fame is probably a good starting point if you don't happen to be Warren himself.



* Buffett, in this video, did not mention that this also applies to the truly poor.  There are a whole lot more of these than the truly rich.


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## Triathlete (15 April 2015)

DeepState said:


> Here's a given: you don't get seriously rich by 'dabbling'.  The truly rich take big positions.....*
> 
> 
> Question 1: Under what conditions are highly concentrated positions ('6 businesses' (1:05)), when thought of as a stock level bet, truly appropriate?




I can only speak from my own experience but I look for stocks that are moving up in price and get rid of any that are moving sideways for any extended period of time and  also get rid of any that have turned down which are in the portfolio,this is  actively managed portfolio . 

All my selections are  confirmed by my technical analysis bias but I also make sure that they are fundamentally sound companies as well.

By using this technique I am able to generate much higher returns then the market.

Over the past 8 months this concentrated portfolio ( I have two that I run the other has 9 stocks in it ) had only 3 stocks in them 2 x top 20 and 1 x top 100 ,presently that portfolio has one ( top 100 stock)which is still moving up but am expecting a correction shortly so I have a trailling stop 5% below but over this 8 months has shown 50% return pa capital growth only.

 I have closed out the other 2 positions and waiting to get back in when the time is right.The return so far on a PA basis is 39% includes div for this concentrated portfolio.


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## Triathlete (15 April 2015)

What are people views on this statement?

I have learnt and read that holding between 5 - 12 stocks is best as anything above 12 stocks exposes the portfolio to market risk,which cannot be eliminated by diversification.

Thus, any attempt to reduce volatility by increasing the number of stocks held actually decreases the ability of a portfolio to outperform the market because with each additional stock you are increasing your exposure to market risk, resulting in average returns at best.


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## galumay (15 April 2015)

Triathlete said:


> By using this technique I am able to generate much higher returns then the market.




The problem is that statistically this is meaningless and you have no way of knowing whether its a bad technique that has got lucky, or a good technique that has got lucky, or a good technique without any luck. 

The maths is pretty straightforward, but to likely exclude luck as a causal factor you need to consistently outperform the market for very many years. Of course even then it doesnt prove it wasnt just luck, but it becomes statistically improbable. There are very few investors in the world that can confidently say that their strategy or technique succeeds because of its own design and not because of luck.


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## galumay (15 April 2015)

DeepState said:


> Clearly there are many paths to Rome. .[/SIZE]




Without answering all your points in detail, i think this is the real learning. Like everything in life, there are few absolutes, most questions have answers in shades of grey, not black and white.

I think the other thing you have to be aware of with Buffett is that he is speaking in 'Omaha', the meassages might sound simple and clear, but I suspect more often than not he is simply trying to get his listeners to engage in second level thinking and unpack his simplistic, motherhood statements and think about the component parts and context.

Often when I read something Buffett said, rather than just accept it literally it inspires me to go and research the concept and improve my understanding. As you allude to, none of us will ever be another Buffett, for one thing even he suggests he couldnt achieve his record if he had to start in todays markets, so trying to emulate him is futile.

To drag the conversation back to diversification, i think its clear there are many ideas out there about the ideal way level and method of diversification, I guess the best we can do is truly understand what we are trying to achieve with a specific type of diversification, consider all the unexpected results that may occour and choose a strategy that we are comfortable with in terms of personal investing philosophy, emotional type and risk management.

It is interesting to think of diversification in other contexts too, from an internal business point of view its often considered high risk and contrary to the concept of concentrating on your core business. Similarly entrepreneurs tend to harvest one great idea and put all their capital, energy and intellect into developing that, diversification would be seen as very high risk and counter productive. 

I dont think people should regard diversification as a panacea, nor should they dismiss it as something that never adds value.


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## DeepState (15 April 2015)

Triathlete said:


> What are people views on this statement?
> 
> I have learnt and read that holding between 5 - 12 stocks is best as anything above 12 stocks exposes the portfolio to market risk,which cannot be eliminated by diversification.
> 
> Thus, any attempt to reduce volatility by increasing the number of stocks held actually decreases the ability of a portfolio to outperform the market because with each additional stock you are increasing your exposure to market risk, resulting in average returns at best.




Risk = volatility in this context.

You are exposed to market risk from the very first stock added to your portfolio.  Depending on the stock, 'market risk' whatever that actually is, might be a relatively small portion of total risk.  As you add more stocks, in general, volatility from market risk increases as a proportion of total portfolio risk.  Total portfolio risk generally declines. The closer the portfolio effectively becomes to the 'market' in its composition, the less ability it has to outperform it as a tautology.  Conversely, increasingly matching the index reduces the opportunity the portfolio has to underperform it too.

Number of stocks matters a lot less than the composition of the portfolio itself for all of the above statements.  A portfolio with 200 stocks in from the ASX it can perform vastly differently to the ASX 200.


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## DeepState (15 April 2015)

galumay said:


> Its pretty clear what his view is on portfolio diversification, he states it in simple terms in the linked videos and in other interviews, writings, transcripts etc.








galumay said:


> ...the meassages might sound simple and clear, but I suspect more often than not he is simply trying to get his listeners to engage in second level thinking and unpack his simplistic, motherhood statements and think about the component parts and context.





Maybe it's not so simple and clear after all.




galumay said:


> I dont think people should regard diversification as a panacea, nor should they dismiss it as something that never adds value.




+1


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## DeepState (15 April 2015)

Last one for this spurt.  

“I'm 15% Fisher and 85% Benjamin Graham.” Warren Buffett 

Graham and Diversification:





Fisher and diversification:




Note the reference to 10 to 12 LARGER companies in a VARIETY etc.  In the US those larger companies are much larger than the stuff that dominates the threads in the sharescene of ASF.  All of those could fit into one US mega-cap with space to spare.


Not Fisher, Graham, Soros, BRK Portfolio Heirs, Fink, Dalio, Marks, Lynch....actually recommend or use 6 (or whatever very small number) stock portfolios.  

Doesn't make it totally wrong for particular situations, however arguing that Buffett does it and thus it must be so assumes that the other conditions that make it right for Buffett also apply elsewhere....

Furthermore, crack open a BRK-US annual report and actually count the number of companies that are invested in to make that entity what it is.  Look at the full portfolio that actually is BRK-US, let alone the float assets.  You'll need more than two hands.


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## galumay (15 April 2015)

DeepState said:


> Last one for this spurt.
> 
> Not Fisher, Graham, Soros, BRK Portfolio Heirs, Fink, Dalio, Marks, Lynch....actually recommend or use 6 (or whatever very small number) stock portfolios.
> 
> ...




Did anyone actually argue specifically that Buffett holds a very small number of stocks?  He certainly encourages the idea of holding a relatively small number - if you are a good enough analyst. (the punch card concept)

To be fair there are other reasons for BRK holding a larger number of companies, the sheer size of them makes it difficult for them to hold a small number of positions. (unless they owned 100% of a small number of rather large companies!)


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## luutzu (15 April 2015)

DeepState said:


> ...assume that you might not quite be as good as the presumptive heirs, let alone Buffett.





To badly paraphrase Machiavelli: 

The intelligent investor, in wishing to hit a lowly and distant target, ought to be like an archer and aim high above that modest goal. He thus ought to study the thoughts and actions of the great and the wise, and in him trying to emulate such greatness and fail, he will at least not drive his entire savings through the ground.

The super duper intelligent investor, in wishing to hit a moderate target, and in seeing that there is only one great and mighty Buffett, shy away and follow the advices of brokers, consultants, and other masters of the universe (who periodically crashes economies, wipe away people's life's savings but otherwise generally did just about so so) and thought it's the smartest and safest way to do just so and so like them.



Trick question: If I buy the Lotto and a PowerBall... does the chances of me winning both the Lotto and the PowerBall increased because I bought both? My year 10 introduction to probability tells me that the chances are the same - something about independent event and what not.

So if I blindly diversify and buy stocks on the ASX, and also stocks on NYSE, and some from emerging markets... some math genius or MBA could somehow tells me my equity risk is reduced because... beta and alpha and gamma says so?

Ah well, simple minds like myself have to do simple things.


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## luutzu (15 April 2015)

DeepState said:


> Last one for this spurt.
> 
> “I'm 15% Fisher and 85% Benjamin Graham.” Warren Buffett
> 
> ...




I heard Munger said that without a "handful" of great buys, Berkshire's performance is a joke.

"Handful"... so 5? 10? 

See.... Geico, Sees Candy, Coke, Washington Post, Amex... Goldman [?]


Seriously, who take Buffett's "six" or twenty investment decision literally like that?

I thought the idea behind that was to know what you're buying, and if you're sure it's the real thing, buy it big... don't buy willy nilly... That and big opportunity does not come that often... but if it comes in 50 or 100 and you got the cash and the certainty, dig in.


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## DeepState (16 April 2015)

galumay said:


> Did anyone actually argue specifically that Buffett holds a very small number of stocks?  He certainly encourages the idea of holding a relatively small number - if you are a good enough analyst. (the punch card concept)
> 
> To be fair there are other reasons for BRK holding a larger number of companies, the sheer size of them makes it difficult for them to hold a small number of positions. (unless they owned 100% of a small number of rather large companies!)




No-one specifically argued that Buffett holds highly concentrated positions. He does. That is not a point of debate. What is under consideration is diversification in portfolios.  

What you will have seen, even on this thread alone, is argument against diversification with Buffet's name nearby as a supporting justification complete with an obligatory motherhood quote or two. 

You will also see references to holding concentrated portfolios for lack of ability to generate and maintain detailed knowledge. On at least some occasions, this is justified on the basis that investment is all about buying only what you know very well...implied by practice as being at the stock level.

Regrouping my points:

1. Buffett holds pretty decent diversification per the Fisher model.  If you have less than 20 stocks, the bulk of which are in large, stable, businesses of different types, then you are likely under-diversified in the equity portfolio, particularly if this represents a decent portion of your assets.

2. If you know less than Buffett, then, in an extension to his own advice, it is appropriate to take a step towards highly diversified exposures to the equity risk premium alone.  In at least some cases, those who know less than Buffett choose to hold very concentrated portfolios by stock count, by exposure to less stable/projectable earnings streams and/or by economic exposure.

3. If Buffett is invoked as a justification to maintain these types of portfolios, it is actually going against his practice and those of a great many other fantastic investors.

4. If you overestimate your abilities, but otherwise emulate the practices of those who are truly skilled, you are highly likely to be doing yourself a disservice.   Given a reasonable working assumption is that there is at least a 99% chance that you are not as good as Buffett, some nod to highly diverse portfolio settings might be appropriate.  It is important to calibrate risk with appropriate expectation.  If you act in a manner consistent with being omnipotent, but are knowingly or unknowingly not so, excessive risk is being born.  It isn't an issue of aspiration.  It is an issue of calibration. 

5. If you truly do understand risk management, are not over-constrained by various factors, and yet choose to hold concentrated portfolios then at least that is a direct and informed decision. It can be perfectly appropriate in the right circumstances.  

6. Buffett deliberately sought to price BRK shares out of the market for a class of investors which would encompass many of the participants likely cruising around in ASF.  Even for them, Buffett judged, BRK was too volatile.


If you
+ cannot afford to buy a BRK-US head stock; and/or
+ hold concentrated portfolios because of bandwidth or from trying to emulate Buffett or from thinking you are better than Buffett (perhaps as part of a positive mental attitude endeavour); and
+ seek to justify high concentration on the basis that this is what Buffett does.... 

1. Buffett would not advocate it.
2. You might wish to consider buying other stuff you know less well but think will likely go up over the longer term.  You may, for example, believe in the concept of equities as having an equity risk premium...as Buffett does.  It would lead you away from very concentrated portfolios.


Ok, that's it.


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## Triathlete (16 April 2015)

galumay said:


> I think its clear there are many ideas out there about the ideal way level and method of diversification, I guess the best we can do is truly understand what we are trying to achieve with a specific type of diversification,* consider all the unexpected results that may occour and choose a strategy that we are comfortable with in terms of personal investing philosophy, emotional type and risk management.*




I agree with this statement Galumay....and this is the way I look at diversification presently.


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## Triathlete (16 April 2015)

DeepState said:


> Risk = volatility in this context.
> 
> You are exposed to market risk from the very first stock added to your portfolio.  Depending on the stock, 'market risk' whatever that actually is, might be a relatively small portion of total risk.  As you add more stocks, in general, volatility from market risk increases as a proportion of total portfolio risk.  Total portfolio risk generally declines. The closer the portfolio effectively becomes to the 'market' in its composition, the less ability it has to outperform it as a tautology.  Conversely, increasingly matching the index reduces the opportunity the portfolio has to underperform it too.
> 
> Number of stocks matters a lot less than the composition of the portfolio itself for all of the above statements.  A portfolio with 200 stocks in from the ASX it can perform vastly differently to the ASX 200.





Thanks DeepState for your explanation on the topic.


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## galumay (16 April 2015)

DeepState said:


> ....
> 
> Ok, that's it.




All of that is well reasoned and clearly articulated as usual, DS. 

My only comment would be to suggest that we should still be wary of seeing diversification as a panacea, there will be opportunities and times in your life when diversifying is exactly the wrong thing to do, the least risk will lie with the most concentrated position. The incredibly difficult part is being able to recognise them and have the mindset to act.

We also have to remember the tradeoffs with high diversification, and make sure we have means to manage the attendent risks.

I think there is a tendency to look for quick and easy solutions in life, diversification sounds like one of them to a lot of investors.


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## Triathlete (17 April 2015)

jeremykl said:


> thanks everyone for your feedback so far.
> 
> From my research, I found this study which shows that you need 38 Aussie stocks to achieve a diversified portfolio ...




You may have diversification with 38 stocks but what is the average return of a portfolio that size. It would be interesting to see some charts over a 12 month or longer period to see which way the stocks are moving.

You may fined that 1/3 are moving up in price maybe higher in a bull market .1/3 are moving sideways and 1/3 are moving down I would find it hard to believe that this would be the best way to generate the best returns on any portfolio.

Yes you still might have a dividend coming in but for me the first thing I always look for in any stock is capital growth the dividend is the icing on the cake.

I am still of the belief that you only want stocks moving up in the portfolio and get rid of any moving sideways for an extended period and those that are moving down to get the best returns for the portfolio ,off course this would be an actively managed portfolio.

The only time I would hold down trending stocks is if I was going to take a short position.


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## luutzu (17 April 2015)

My take away from Graham/Dodd, Fisher... Buffett probably got it from them too (or he might come to it independently):

If you don't know, or don't care to know, or have no interest in getting to know the individual business each of your stock holding represents... then diversify into an index fund. An index fund is cheap, it follows the market (it is the market)... and in the long term, the market (through the businesses it represents) generally do well.

So indexing, or diversification to the extent that it almost replicate the index, is cheap, does not consume much time and effort, does not require an active interests in the stock and the market... and over the long term will generally do well and are relatively safe.

BUT...

But if you do not index and want to buy individual stock - be that buying one, five, ten or thirty... what you are saying is this: I know what I am doing; I know why I chose stock A instead of the other 2000+ stocks; I know how much I'm expected to gain from each, and why, and when I would want to get out etc. etc....

In other words, when you start to be selective in your investing, you ought to be selective because you know why you select one stock over another.

Such knowledge and gahoonies implies, obviously, that you have a keen interest in the market and the businesses listed on it and know the good from the bad and the ugly - and select the good and avoid the bad just like Woolworths' "Select" homebrand is no ordinary home brand because it's "Select", by Woolworths 

So, for most, say "99%", of investors... they ought to index because to do otherwise means this:

1. They have to be a business analyst; with knowledge and training that rivals one; OR
2. Get financial advice, from those knowledgeable advisors and their fine prints; OR
3. Be rich enough to be the chosen few worthy of "selective", "personal" and "private" management by the gurus and their 2/20, heads I win tails you lose, fee structure.

Since option 2 and 3 is not a good idea, the selective or enterprising investor must necessarily be 1 - the business analyst. And if your day job is not in finance and business, and you have no interests to learn the trade... probably best to index.


I thought such advice, while simple, makes sense.

To quote mother Benjamin Graham and David Dodd, to do average on Wall St is easier than it looks; to do slightly better is more difficult than it seem.

And I am definitely sure they, and Buffett, say those stuff before these "modern" theory of portfolio management and their Greek alphabet.

But you know, keep up the good work. I don't mind.


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## Value Hunter (21 April 2015)

Another issue is stocks as a percentage of overall investments and your diversification outside of stocks. Many investors including myself hold investments other than shares. My whole share portfolio is currently invested in one company - Credit Corp (CCP) but I have other investments apart from shares. This is an important factor which needs to be considered when discussing diversification in the share market.


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## QuietGrowth (15 November 2015)

Diversification through ETFs is preferable than through individual stocks (less expensive).

It is preferable if you invest in a risk-optimised portfolio that is customized for you, with the portfolio consisting of various low-cost index ETFs across different asset classes. The more the diversification of this global portfolio, the better. (For example, each of the 5 portfolios that our firm QuietGrowth offers, has 8 ETFs across different asset classes.)

Then you would need to constantly rebalance the portfolio whenever the drift of each of the ETFs in the portfolio becomes significant. Also, you would need to re-allocate the mix of your portfolio, whenever it is appropriate.

All this takes a fine amount of skill, knowledge and discipline, so it is difficult for everyone to put it into practice. However, this approach will give you better returns in the long-run compared to simply investing in few favourite index funds.

Dilip
QuietGrowth


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## galumay (15 November 2015)

QuietGrowth said:


> All this takes a fine amount of skill, knowledge and discipline, so it is difficult for everyone to put it into practice. However, this approach will give you better returns in the long-run compared to simply investing in few favourite index funds.
> 
> QuietGrowth




Its not definitive, it MAY give you better returns. Thats all you can say with any certainty. Diversification is always a double edged sword, there are ample arguments against diversification for diversifications sake. 

If you are good enough then your universe of companies invested in should be very small indeed - potentially just one. Its self evident this will maximise your returns - if you are good enough and have sufficient confidence in your skill!


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## QuietGrowth (15 November 2015)

galumay said:


> Its not definitive, it MAY give you better returns. Thats all you can say with any certainty. Diversification is always a double edged sword, there are ample arguments against diversification for diversifications sake.
> 
> If you are good enough then your universe of companies invested in should be very small indeed - potentially just one. Its self evident this will maximise your returns - if you are good enough and have sufficient confidence in your skill!




Yes, if you know more than the market, that is, you can predict correctly, then yes, diversification is meaningless. You have that one single winner stock, and it will make you a winner.

Now the moot question is: do we really know who is that future winner?

Almost always, we do not. -> Unless we know more than the market.

This is what Efficient Market Hypothesis is all about. Hence the case for diversification.


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## DeepState (15 November 2015)

QuietGrowth said:


> Yes, if you know more than the market, that is, you can predict correctly, then yes, diversification is meaningless. You have that one single winner stock, and it will make you a winner.
> 
> Now the moot question is: do we really know who is that future winner?
> 
> ...




Hi Dilip, nice to have an(other) informed posted join ASF.  As I mentioned in another post, please respect that ASF is not a platform for sourcing clients for financial advice or services including funds management.

Galumay is correct.  

When you make this claim:



QuietGrowth said:


> ...this approach will give you better returns in the long-run compared to simply investing in few favourite index funds.




It does not require superior knowledge of the market for a concentrated portfolio of whatever to beat a fine-tuned portfolio of ETFs.  There is a probability distribution.  Over any worthwhile and relevant investment horizon, some random selection of ETFs has a non-zero and often meaningful chance of outperforming in straight out return space.

...  Unless you are claiming to have a massive edge in asset allocation, which would be at odds with a highly diversified portfolio which is rebalancing via threshold rules.


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## QuietGrowth (16 November 2015)

DeepState said:


> Galumay is correct.
> 
> It does not require superior knowledge of the market for a concentrated portfolio of whatever to beat a fine-tuned portfolio of ETFs.  There is a probability distribution.  Over any worthwhile and relevant investment horizon, some random selection of ETFs has a non-zero and often meaningful chance of outperforming in straight out return space.
> 
> ...  Unless you are claiming to have a massive edge in asset allocation, which would be at odds with a highly diversified portfolio which is rebalancing via threshold rules.




Yes, probability distribution exists. Hence there is a non-zero probability of beating a fine-tuned portfolio of ETFs, the reason involving skill and/or chance.

Yes, galumay is correct. There will always be instances that satisfy what he stated. For sure. However, one cannot deny the case for the benefits of diversification.


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## galumay (16 November 2015)

QuietGrowth said:


> Yes, probability distribution exists. Hence there is a non-zero probability of beating a fine-tuned portfolio of ETFs, the reason involving skill and/or chance.
> 
> Yes, galumay is correct. There will always be instances that satisfy what he stated. For sure. However, one cannot deny the case for the benefits of diversification.




Its probably worth your while reading this thread in its entirety, there is some really good discussion about the pros and cons of diversification. I think its become a bit of a buzzword and something that people just accept as being beneficial without any deeper understanding.

Also in your previous post you mention the Effecient Market Hypothesis, I think that it is widely accepted now that it is a false hypothesis.


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## skyQuake (16 November 2015)

A bit off topic but has anyone read "Poor Charlie's Almanack?"
https://www.poorcharliesalmanack.com/pca.php
No kindle version so it has to be shipped from the US for a pretty (outrageous) sum


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## McLovin (16 November 2015)

skyQuake said:


> A bit off topic but has anyone read "Poor Charlie's Almanack?"
> https://www.poorcharliesalmanack.com/pca.php
> No kindle version so it has to be shipped from the US for a pretty (outrageous) sum




Yes. It's a big book, more like a coffee table book than a read in bed book. It's worth reading though. Munger is a different sort of thinker to Buffet, or Buffet synthesises his thinking differently.


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## galumay (16 November 2015)

skyQuake said:


> A bit off topic but has anyone read "Poor Charlie's Almanack?"
> https://www.poorcharliesalmanack.com/pca.php
> No kindle version so it has to be shipped from the US for a pretty (outrageous) sum




Its available as a PDF if you hunt around.


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