We’ve been talking for a month now about the value of having a more concentrated portfolio. This week we’ll cover the final steps in the process.
Let’s get started with a quick review.
Our thesis is that individual investors can make more money – a lot more money – by having a more concentrated investment portfolio. We’ve supported our thesis with evidence in these recent articles, Trimming an Overloaded Portfolio and Making More with Less.
Last week, we offered some first steps for trimming down your portfolio holdings. You can review the details here but the quick summary is:
- Think like a business person. As an investor, you are a business owner after all.
- Get rid of the businesses that aren’t making you money.
- Get rid of any businesses that are wildly volatile (i.e., have a VQ > 50%).
Alright. Let’s put the finishing touches on this strategy of making more money with fewer investments.
The next step in the process is to make sure that you’re sufficiently diversified. We’re not talking about Markowitz style modern-portfolio-theory diversification here. You just need to be sure that you don’t have all your eggs in too few baskets.
You can do that on your own by looking up the sector for your investments on sites like Yahoo Finance or Google Finance and then figuring out how much money you have invested in each sector.
If you’re a TradeStops Premium or Lifetime subscriber, then you can use the Asset Allocation tool from the Research section to analyze your portfolio holdings.
Here’s what our model portfolio sector diversification looks like after completing steps 1, 2, and 3 above.
Our largest percentage is invested in technology stocks, but it’s less than 20% of the overall portfolio. The investments are spread across 9 different sectors. No sector represents more than 20% of the portfolio or less than 5% of the portfolio.
There’s no basket here with too many (or too few) eggs. If you do find that you’ve got too many eggs in one basket, you can look at the investments that are in that sector and keep your best performers.
So, we’ve hopefully done some serious portfolio trimming by now, and we’re left with a solid group of investments that are performing well for us, aren’t too wildly volatile, and are nicely diversified.
Now it’s time for the most important step of all – pick the investments that you like the most.
I’m sure that some readers will wince at the notion that something as trivial as personal preference could positively impact investment returns, and I doubt that I’ll ever get the claim published in an academic journal. But hear me out.
First of all, I strongly believe that investing should be enjoyable. You’ve done the hard work of making sure that you’ve got a solid base of investment ideas to work with. There’s no harm done in now just saying, “I like these investments the best.”
But even more importantly than indulging your personal preferences a little bit, there’s the very subtle matter of confidence… and conviction.
There’s no denying that we are emotional. Our emotions are going to play a role in our investment decisions whether we like it or not. By exercising a little emotional discretion in our portfolio selection, I firmly believe that we are positioning ourselves to be able to better weather some of the emotional ups and downs of investing.
There’s plenty of behavioral research out there that supports my thesis as well. My favorite source is a book called Risk Savvy by Gerd Gigerenzer. Gigerenzer makes a very compelling case that when it comes to decision making in data-rich fields (like investing), often times the best decisions are made with LESS information and by listening to our gut.
That’s not something you hear from the financial experts and academics very often… and it’s a big part of the reason that I’m not an academic.
