by Marin Katusa, Katusa Research:
One of the most common questions we receive at Katusa Research concerns the number of stocks an investor should own.
Is 10 the right number of stocks to own?
Is 20 the right number?
Is it 50…or 100?
The number of stocks you own has a huge effect on your performance. In this essay, I’ll walk you through my thinking on this critical topic. I hope it helps you make great decisions with your own portfolio.
First of all, you should know that I have some unconventional beliefs about the number of stocks an investor should own.
These beliefs work for me. They may not work for you. Your financial advisor might say these beliefs are risky, but I happen to know they are incredibly profitable. And you should at least know my line of thinking. You should also know that many of the world’s best investors (including the legend Warren Buffett) agree with me.
My belief–and the incredible power behind it–can be summed up with the word “concentration.”
How the Pareto Principle Can Make You Wealthy
You’ve probably heard about “diversifying” your stock portfolio. This is the idea that an investor should own dozens or even hundreds of different stocks.
Spreading your investment dollars around reduces the risk that troubles at a single company could wreck your portfolio. For example, you don’t want to lose half your money in a meltdown like Enron.
For people who don’t want to work on their investing, diversity is a good idea. Rather than trying to select individual companies, they can own hundreds of stocks…through a mutual fund or an ETF.
Owning hundreds of stocks is simple and easy. And it will earn you average stock market returns. In fact, buying an index fund is what most investors should do. It’s a good “set it and forget it” option for people who don’t want to work on their investments.
But if you are willing to do extra work in order to earn extra returns, should you own 200 or 300 stocks?
I say “NO WAY.”
I don’t know about you, but I believe in focusing my efforts in every area of life. I don’t chase dozens of business opportunities every month. I focus on a small group of really, really big opportunities. I don’t try to keep up with dozens of friends. I focus on the small group of people I’m closest with.
Ever hear of the Pareto Principle?
It says that 80% of your results come from 20% of your efforts. For that reason, it’s also called the “80/20” rule. For example, your business may generate 80% of its sales from 20% of your clients.
Long-time readers have heard me say that 20% of resource operators create 80% of the value in the sector.
I’ve taken Pareto’s principle a step further. Years ago, I coined the 64/4 rule—I took the 80/20 rule and subjected it to Pareto’s principle again. The result states that 4% of entrepreneurs create 64% of the wealth (80% of 80% is 64%, 20% of 20% is 4%, hence the 64/4 rule).
Productivity experts agree that people should concentrate their efforts on the “magic” 20% that really produces results.
I believe it should be the same with investments.
Why chase dozens of mediocre ideas?
Why not concentrate and focus on the really big ideas?
If I can own 8 – 14 exceptional opportunities that I know inside and out, why would I water down my results and own 100 or 200 companies? There simply are not 100 or 200 truly exceptional opportunities in the market at any given time. The market doesn’t work like that.
You might see things like I do. If so, you’re in the same boat as the world’s best investor, Warren Buffett. Rather than buy hundreds of stocks, Buffett has always focused his time and efforts on a small group of businesses he can truly understand and track. Buffett has said that diversification, “makes little sense if you know what you are doing.”
Buffett’s focus on a small group of great businesses he can understand and monitor has helped him become the most successful investor in the world.
If you chase hundreds of opportunities, it’s inevitable that you’ll lose focus on the biggest and best opportunities. You’ll dilute your efforts. You’ll achieve mediocrity. And consider…
How Many Resource Firms Can One Guy Really Understand?
It takes a huge amount of time and work to really understand and monitor a resource business.
It requires balance sheet analysis, geological analysis, meetings, phone calls, and site visits to really understand a resource business.
Even the most dedicated, hardworking business analysts can’t do all of the necessary work to really understand and monitor more than 25 companies at a time. If an analyst says he covers something like 40 or 60 companies, some of his analysis is sure to be superficial.
Yet some analysts cover more than 100 stocks. I’ve met individual investors that own over 100 stocks. And some mutual fund managers own more than 300 stocks!
You can do what you like, but I’d much rather own a small, concentrated group of companies that I can genuinely understand and track. I want to concentrate on the biggest and best opportunities, ignore the rest, and generate big returns. This thinking is in contrast to the thinking at many large investment funds and many investment newsletters, but it has worked wonders for me.
Please follow SGT Report on Twitter & help share the message.