Stock Diversification

[Libertarian]

Hi everyone. I am a former Hedge Fund trader who now invests his own capital. I have spent a lot of time trying to work out an investment process to value companies. The first and most crucial issue to me is how much capital do I allocate to shares. I have decided to use the following portfolio allocation rules.

I must be risk averse with my family’s capital
I must be risk averse with my family's capital because if I doubled our capital the impact on my family’s life would not be that significant, whereas, if this capital halved, the impact would be enormous. Warren Buffet explained how foolish it is to take unnecessary risks when he said:

“It is foolish to risk something that is important to you for something that is unimportant to you. I do not care if the odds you succeed are 99 to 1 or a 1000 to 1”.

He went on to use the excellent analogy:

“If you hand me a gun with million chambers with one bullet in a chamber and put it up to my temple and I'm paid to pull the trigger, it doesn't matter how much I would be paid. I would not pull the trigger - yet people do this financially all the time without thinking.”

How I will allocate my family’s capital
I will simply invest my family's capital in assets where I think the probable return justifies the risk. I will not decide where to invest my family's capital based on the recommendations of some asset allocation model or portfolio optimisation theory.

I will focus on absolute not relative performance
What I want to do is preserve my family’s capital and get a good long-term return on this capital relative to the risk. Whether the short-term returns I get on this capital are much lower than the returns from investing it in ‘the market’ (for example, a passive index fund) is irrelevant.

I must not invest more than 10% of my family's capital in a separate industry
I have a 10% limit for investing in an industry because of the risk that my family could lose most of that capital. This could occur because some unforeseen event (such as the invention of the internet) makes the industry far less viable and, thus, the intrinsic value of businesses in the industry falls dramatically.

I must not invest more than 5% of my family’s capital in an individual business
I have a 5% limit for investing in an individual business because of the risk that my family could lose most or all of this capital. This could occur because I paid far too much for the business (I seriously overestimated its intrinsic value), or that bad luck significantly reduces the business’s intrinsic value.

Much more to come...

 

[Bushman]

Hey Lib - there is already a Warren Buffet thread.

See the link below


https://www.aussiestockforums.com/forums/showthread.php?p=530457&highlight=warren+buffet#post530457

 

[Tysonboss1]

If you wish to follow buffet you should know he doesn't recommend an active investor use diversification, He recommends investing in no more than 6 companies and have half you net worth in your favourite.

It seems you are really really conservative, Why not just stick half you funds in direct property and half in an ASX 200 index fund.

 

[PrudentInvestor]

I must be risk averse with my family’s capital
I must be risk averse with my family's capital because if I doubled our capital the impact on my family’s life would not be that significant, whereas, if this capital halved, the impact would be enormous.

How I will allocate my family’s capital
I will simply invest my family's capital in assets where I think the probable return justifies the risk. I will not decide where to invest my family's capital based on the recommendations of some asset allocation model or portfolio optimisation theory.

May I ask why you choose to ignore portfolio optimization altogether if your goal is to minimize risk? As far as I'm concerned, the idea of quantitative - or model based - portfolio management is to keep the risk-return profile of a portfolio on a predefined area by providing optimal allocation weights. In your case, such models would help minimize the portfolio risk, assuming that you'd already done your due diligence while selecting the risky assets.

 

[wns]

Hi Libertarian, this looks like it will be a very interesting thread.

What does your investment universe consist of? ASX listed businesses only? Or is it broader than that?

 

[Libertarian]

I am risk adverse because I have a significant amount of capital.

I do not use portfolio optimisation models because I think it is far less risky to buy say 20 'cheap' companies that I understand than x number of companies recommended by some portfolio optimisation theory.

I currently own ASX LIC's. All of which were bought at significant discounts to their net tangible asset value. I have previously invested in non LIC ASX companies and US companies.

 

[gooner]

Interesting comments

I take a very conservative approach in my SMSF with mainly blue chip companies and most of the $$ (probably 80% in top 20 companies). Compared to the index I am overweight energy and underweight financials, due to a belief in peak oil and overpriced Australian property. The reason for the conservative approach is that a 100% gain would be nice but not change my lifestyle much, whereas a 100% loss would be devastating - no fun on the Australian old age pension.

I take more risk in my assets out of super, with some investment and some trading. But not that much risk - never go outside ASX 200. NXS being a rare (and expensive) exception.

 

[craigj]

liberterian
if you are looking long term then there is no rush to enter the market
choose stocks that u like and believe in then determine at what price the share is undervalued and wait for that price

 

[venger]

if one is happy with the average business return of 12-15% (nominal), then the low cost index fund will do it.. no trading, no one to mess things up..

trouble is, it is tempting to think that it is easy to outperform (myself included)..

i really do wonder.. after fees and taxes, how many of us small investors really do beat the low cost index fund... or the older LICs (argo,etc)

recently, was in discussion with a mate of mine on shares.. and he quite candidly said that for all his buy and hold approach over the past 10 years.. he's doing a little worse than the index (before fees&taxes!)...