The Portfolio MYTH-----Do you need to change your thinking?

[DeepState]

Some people put most of their life savings in the home they own, some people put their life savings in the small business they own. In either scenario most people will not bat an eyelid. Suddenly if somebody wants to put a huge chunk of their life savings in a single stock people think they are nuts.

Or maybe the primacy of home as a store of wealth hasn't been tested in 30 years....and they are about to find they really were nuts all along. How many small businesses survive 12 months?

 

[Value Hunter]

Lets say hypothetically you are a family living in Sydney. You buy a house with 80% leverage and move into it (owner occupied). Even if house prices dropped 50% over the next 5 years, assuming that you can still make the repayments and are happy to live in that house, its not the end of the world. In 150 years time when your grandchildren inherit the house it will probably be worth a lot more than what you bought it for and nobody will even remember or care or know about the fact that the price of the house once dropped 50%.

As for small business just because the business does not survive does not necessarily mean you lost your shirt. For example let's say you open or buy a hostel (the business and the land and building) in Byron Bay. If the hostel does not make money after 12 months you could convert the building into apartments, offices, etc and rent it out. The "hostel" ceased to exist but the assets had alternative use. Also Phoenix companies and dodging taxes and creditors are other factors which obscure small business survival statistics. Another example if you have an internet business with highly quality liquid (in demand) stock, let's say you couldn't turn a profit and shut the business down you could liquidate your stock at say a 25% discount to cost and walk away. A well though out small business should have an exit strategy.

 

[DeepState]

VH, people do lots of different things. If a financial set back is not the end of the world because your future earnings are your real main asset, great. That doesn't excuse dumb actions. It just makes it survivable.

Extreme risk brings extreme outcomes.

In a world of securities where fractional ownership is readily achievable and management input is non existent, 'best approch' invested in one or two stocks, even if conglomerates, with significant personal leverage, is not generally appropriate for most. But it may be for you.

 

[Value Hunter]

Deepstate I think we are both in agreement that for the masses (90%+) of investors index funds are the best choice. Personally I like to think I am awesome and do not want to dilute my awesomeness ;-) Time will eventually tell if I am right or not.

By the way I am still interested to hear why you think fundamental factors do not provide much protection (in the context of my post before which stated fund managers are a sub optimal example).

 

[DeepState]

By the way I am still interested to hear why you think fundamental factors do not provide much protection (in the context of my post before which stated fund managers are a sub optimal example).

Because the knowledge required to achieve those outcomes routinely exceeds our ability to acquire it. Even Buffett makes major errors on individual positions.

 

[Value Hunter]

Deepstate I remember Buffet once stated that his biggest errors tended to be on smaller investments because you tend to be sloppier when commiting a smaller sum. Besides a mistake does not have to mean a wipe out. In many cases the investment can be exited with modest losses as Buffet has done many times before. If you can provide an example when Buffet suffered major losses on a very high conviction investment (I.e. a big chunk of the portfolio I would like to hear it). Sure sometimes like Tesco he makes a mistake but not on the really big positions (at least not since he took control of Berkshire which was a major mistake).

 

[DeepState]

VH, we can go back and forth on this. You are convinced that an essentially single stock position in a levered portfolio is right for you. Good.

The arrangement wouldn't be appropriate for most. Many financial planners have been fined for advising clients to do what you are talking about or something close to it.

Whilst you might be better than Buffett, making his examples useful indicators for you, the chances of this being accurate aren't very high.

People will become very rich, from time to time, doing what you are doing. For most taking this path, the concept of 150 year outcomes will become more relevant. Hopefully that's not the path ahead for you, but it absolutely is much more likely than for someone investing their assets in an index fund without leverage. And that will be so even if you know more about Soul Patts than the management of the company themselves and watch it 24/7.

Hope it works out. Hope for the best and all that.

 

[Value Hunter]

I do not hold Soul Patts but I get your point and thanks for the best wishes. I will let the forum know in 5 to 7 years time how my concentrated portfolio worked out.

There is a lot of intelligent debate in this thread

 

[minwa]

Minwa owning an index fund (or 20 individual stocks, etc) does not eliminate the possibility of a big move against you as would have occurred in 2008.

I never said a big move can't happen against a basket of stocks. It certainly can and does happen. The probability is just lower than being in a single stock where you are exposed to a 2008 crash AND the individual stock's own risk. Systematic risk + unsystematic risk.

If probability of a market crashing is 10% - you are at roughly at a 10% risk of a large DD.

This rises when you are majorly in one stock. You are exposed to both the above 10% AND the risk of a unexpected poor quarter/scandal/industry risk.

You are exposed to risk no matter what you do, even in cash you are exposed. It's about reducing that risk for most people and being in 1 stock just isn't doing that.

 

[luutzu]

Deepstate I remember Buffet once stated that his biggest errors tended to be on smaller investments because you tend to be sloppier when commiting a smaller sum. Besides a mistake does not have to mean a wipe out. In many cases the investment can be exited with modest losses as Buffet has done many times before. If you can provide an example when Buffet suffered major losses on a very high conviction investment (I.e. a big chunk of the portfolio I would like to hear it). Sure sometimes like Tesco he makes a mistake but not on the really big positions (at least not since he took control of Berkshire which was a major mistake).

Let me summarise all these back and forth for you.

DS is an investment professional. That mean he's very good at making money (for himself) while not having losses (he might cause, of other people's money) landed at his feet.

Hence, a lot of time and brainpower are spent on rocket-science level of maths to, one, make people afraid to ask anything they "don't understand"; two, to justify the spreading of people's money all over the place to "reduce risk".

For us chumps, if we pick a stock and back it up with our own cash.. and the future turns out wrong, or we've made a mistake. We'd be the one wearing it.

For people in DS's profession, doing stupid thing like that mean a lot of hardwork and you'd get fired or demoted if you or your conviction turns out wrong. Hence, you play smart and diversify the blame.

Since Peter Lynch wrote about how a typical Wall St analyst would rather pick IBM than, say Microsoft, because if IBM goes down, the boss will be asking what the heck is wrong with IBM... if the analyst get clever and pick a newby upstart and it goes down... it's what the heck is wrong with you.

This being the 21st century, computer power being cheap and datasets are all over the place... there's more feathers to play the same game of "I didn't do it".

 

[Value Hunter]

Deepstate what is you view on rebalancing? If you had an equally weighted portfolio of 20 stocks and after 5 years one stock went up 100 fold (100 bagger) and dominated your portfolio what would you do?

 

[craft]

Yes Craft it is, the stock representing 25-30% of my gross assets (and a much higher chunk of my net assets is Credit Corp Group (CCP). And I am happy with it. I know you think it is a risky company but I disagree with your assessment.

Boy I hope you mean you disagree as to whether the risk is worth it rather than disagreeing that risk exists in what they do (running off bad debt ledgers and sub-prime lending), the difficulty of the assumptions that underpin the accounting and how they finance themselves.

Being tolerant to risk is one thing, being oblivious to risk is something entirely different.

 

[minwa]

I do not hold Soul Patts but I get your point and thanks for the best wishes. I will let the forum know in 5 to 7 years time how my concentrated portfolio worked out.

There is a lot of intelligent debate in this thread

Best of luck..even if nothing (hopefully) happens to that one stock, still does not make it a good risk-calculated investment.

Same thing as not using a condom with an infected partner. Odds of contracting are still very low (but much higher than using protection) and you may get away with it, doesn't make it a good decision on a risk standpoint.

 

[Quant]

God there are some shocking Anecdotes in this thread

 

[skc]

Same thing as not using a condom with an infected partner. Odds of contracting are still very low (but much higher than using protection) and you may get away with it, doesn't make it a good decision on a risk standpoint.

I've been wondering what your tag line "well-known offender" refers to.

 

[DeepState]

God there are some shocking Anecdotes in this thread

I think the exchange has been electrifying with near religious fervour.

 

[DeepState]

Deepstate what is you view on rebalancing? If you had an equally weighted portfolio of 20 stocks and after 5 years one stock went up 100 fold (100 bagger) and dominated your portfolio what would you do?

If your view of the 20 stocks is identical in terms of future prospects, then rebalancing to the lowest portfolio risk is the best thing you can do, after taking in to account frictions and tax. There are all sorts of variations in the specifics, but that's the idea. It's a provable maths concept which would require really screwed up arguments to countervail.

 

[Value Hunter]

Yes Craft of course there are risks to the company but I think the risk is worth it. I think all of the risks that you mentioned exist and are meaningful but I think you have overestimated the probability of those risks materialising and underestimated the upside potential.

 

[Value Hunter]

Deepstate real life rarely works that way, who can honestly say they estimate the future prospects of all stocks in their portfolio to be equal? Lets assume that your portfolio stocks had unequal (by your own judgement) prospects and that the 100 bagger stock even after rising 100 fold had the best future prosoects ? What would you do then? Ben Graham in his Graham Newman partnership kept the outsized hlidng in GEICO and eventually spun off the holding to shareholders, many of whom continued holding it. So the type of scenario I describe does have historical precedent (the numbers were different but the essence of the scenario was the same).

We know that Buffet said (paraphrasing) selling your best company\stock because its become too important\large in your portfolio would be like a basketball team selling off or firing Michael Jordon to another team because the team had become too dependant on him.

 

[craft]

Yes Craft of course there are risks to the company but I think the risk is worth it. I think all of the risks that you mentioned exist and are meaningful but I think you have overestimated the probability of those risks materialising and underestimated the upside potential.

You' re possibly right - I do make lots of mistakes with my assumptions about the future, that's why I don't have a one stock portfolio.