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Curious what people think about diversification - specifically how many companies can one effectively follow and still be protected against concentration of risk if it isn't a full-time job? My approach to investing is not very quantitative - I buy companies that lead in their sectors (or are well-respected) with great management, steady profits, and good reputations. Buy low, sell high, but not very often. I see myself as an investor not a trader. The companies grow, so does my wealth. Extra cash (always) sits in laddered muni bonds and high yield savings accounts. Very basic, pretty low risk.

I have about 20 companies in my portfolio, and that number has crept upwards the last few years as I have added in new sectors (i.e., tech and pharma) and kept most of what I had before, including a chunk of B's acquired in the Gen Re deal (lucky day for me!) Even though I like what I own, I do like to follow my companies, and I do need to be able to value them or else I don't know when to buy or sell. I don't need to be precise, I just need to be roughly right. But still, it takes time, and I have a day job and a family that are my priorities.

There is now so much data and news to be digested on each company, and the markets move so much faster, I have started to wonder if I own too many stocks rather than too few. It is my own money so I don't have to put in more effort than I want to. And unlike Jim, I don't spend my free time working on spreadsheets lol. I have added to my BRK along the way (2020 @161, 2022 @271) and it is my biggest single holding, so that provides a measure of safety and diversification, but even BRK takes time to follow (not counting the time I spend lurking here, which is considerable.)

My question for my fellow travelers here is: how any stocks do you have in your portfolios, and how carefully do you follow them? And as a follow-up, how often do you trade?

abromber

"Nobody else has my view. It doesn't bother me. I just think they're all wrong.' Charlie Munger 30 Apr 2022

' 19 positions
' Reviewed quarterly via Value Line and personal number crunching
' Usually sell about two positions per year. Some years have zero selling trades. Purchases are done periodically to deploy accumulated cash. Sometimes this cash is put into new positions and sometimes into existing positions. It depends on the available opportunity choices at the time of purchase. For the most part, these purchases are either when a stock we like gets cheap or when the overall market has dropped. When the overall market drops is when we deploy into existing positions we understand.

Evaluations are mostly done for selecting best opportunity for putting new cash to work. Also, as we have a charitable grantor fund, we usually gift positions with big percentage gains having less likelihood of continued equity value growth going forward. This is our usual path for pruning our portfolio, particularly in years where we are facing considerable income tax to be paid.

I enjoy reading and following business matters, looking at potential investable companies and all the other aspects relating to investing or running our business.

We are still working in our senior years and thus are not needing to draw on our investments for making ends meet. Viva la difference.

Here are two key things to consider--

(1) What is the level of company specific risk in each holding?
There are two parts to that:
(a) Some firms have internal diversification, some don't.
A biotech should have an adjustment factor compared to Berkshire, and Hershey might fall in between the two.
(b) Some firms have specific macro risk exposure, like the business cycle, credit cycle, real interest rates, geopolitical or jurisdiction risk, inflation risk, commodity price risk, or even just fad risk.
For either type of these "company specific risk" factors, even using a bad guess is better than making no guess.
One resilient firm might reasonably have the same allocation as several less resilient ones combined.
Note, I do not recommend using price volatility as a scaling factor!

(2) What criteria are used to pick your holdings? Are they random, slanted based on quantifiable metrics, or seat of the pants?
(by "seat of the pants" I mean selected by yourself based on individual characteristics you believe make a good investment, which might or might not be correct in real life)
A slate of randomly picked firms will converge on the performance of an equally-weighted all-market fund quite quickly. There is probably little point in owning more than (say) 40-50.
For non-random selection methods, you might diverge substantially from the average even with a vast number of positions.

Only with some sort of a handle on those parameters can you start to make generalizations about the amount of diversification that is prudent.
For example, I would never put more than 2.5% of my funds into a firm with average company-specific risks that was picked with a quant method that I thought was sound.
And I won't even approach that these days.
However, my allocation to Berkshire is more than half my portfolio, so it's not because I'm a diversification extremist.

Mr Buffett and Mr Munger have commented to the effect that diversification is just a defence against ignorance.
But, it *is* a defence against ignorance, so it has that going for it.
And almost all of us are far more ignorant about the returns of individual firms that we think we are.

I think most people are best served by buying an equal-weight index fund or two, provided they can get an acceptably cheap entry price and a low management fee.
For those who are passable typists but not skilled investment analysts, these days you can skip the management fees by doing this yourself.
Download the list of index constituents, upload it to the broker site and click "rebalance".
Other than the fees, this has the advantage that it lets you create a blacklist if you like. For example, if you want to skip firms based in certain jurisdictions or industries.

Jim

For those who are passable typists but not skilled investment analysts, these days you can skip the management fees by doing this yourself.
Download the list of index constituents, upload it to the broker site and click "rebalance".
Other than the fees, this has the advantage that it lets you create a blacklist if you like. For example, if you want to skip firms based in certain jurisdictions or industries.

This method also allows you to manage tax considerations. For the S&P, purchase 500 stocks. If you are withdrawing 4% per year, each 3 months sell 5 stocks with the greatest loss, or smallest gain since purchase. Carry losses forward to balance gains when there are no longer any losing stocks. Will work for 25 years if you sell 20 stocks per year.

Craig

This method also allows you to manage tax considerations. For the S&P, purchase 500 stocks. If you are withdrawing 4% per year, each 3 months sell 5 stocks with the greatest loss,
or smallest gain since purchase. Carry losses forward to balance gains when there are no longer any losing stocks. Will work for 25 years if you sell 20 stocks per year.

Hmm, might this not work out to a portfolio that always did a lot more "sell low" than "buy low, sell high"?
You'd also gradually have a lot less diversification as time goes on, and you'd end up holding stocks for a very long time, which isn't always good.

I would be tempted to sell whichever positions have had (say) the lowest EPS growth since purchase date, or perhaps in most recent five years.
The average quality of firm would in theory gradually improve, presumably outweighing the tax increase.


For self indexing, I prefer an approach sort of half way between an equal weight index and a big MI screen.
e.g.,
Decide how much typing you are willing to do for the sake of diversification, e.g., a 80 stock portfolio or whatever number you like.
Buy equal amounts of that many stocks, chosen at random from among the 15% of Russell 1000 stocks with the highest ROE.
Since it's only typing, I'd buy all 150 of them.
Hold a few months, a year, maybe two years if you like. Depends on your tax situation, among other things: presumably Americans with taxable accounts would pick a year.
Rebalance and repeat. i.e., sell any stocks that no longer meet the criteria and replace them with ones that do.
You'll always be holding only those things that meet the index eligibility criteria (or did fairly recently), no short term cap gains tax for Americans except for unforeseeable buyouts.

For people who like to overcomplicate, like me, I'd split it into 4 equal sub-portfolios of different stocks staggered 3 months apart and do a "dozens".
That way you aren't replacing all your stocks the same day of the year, which can cause some issues.

FWIW, a proxy of this using as its universe the 1000 biggest market cap from among the VL 1700 universe beat SPY by 3.12%/year before friction in the last 37.4 years.
Beat the S&P in about 64% of rolling years. Worst rolling year about the same as SPY. The best rolling year at 87% was better than SPY's best year of 63%.
It is a fair bit of typing, and reality is not the same as a backtest, but it probably won't be all that bad.

The underlying reasoning:
Not all high ROE firms are good investments by a long shot--there are lots of duds, bad data traps, and overleveraged bombs.
But all very good very long term investments have high ROE*, so you're getting all of the great ones and eliminating some of the bad ones.
The net result is to improve the batting average a little.

Jim

* except Amazon. Every rule has its exception : )

Buy equal amounts of that many stocks, chosen at random from among the 15% of Russell 1000 stocks with the highest ROE.
Since it's only typing, I'd buy all 150 of them.

Another twist might be to limit it to the R1000 stocks that are also in the VL1700. My count of this is 859 of the 1009 R1000 stocks.

For those who don't have or want an IB account, this portfolio would be easy to do at M1Finance. Maximum of 100 stocks ("slices") per portfolio, 500 stocks per account, minimum order size is $1.00. Specify the weighting you want, or specify "equal balance". Rebalance or change stocks as often as you like.


I guess you could play games with multiple portfolios to have more than 100 stocks in this screen.

Hmm, might this not work out to a portfolio that always did a lot more "sell low" than "buy low, sell high"?
You'd also gradually have a lot less diversification as time goes on, and you'd end up holding stocks for a very long time, which isn't always good.

Using GTR1, the bottom 5 1 year return stocks have a negative return for the next 3 months and 2% return for following year. Basically cut losers, allow winners to run and reap the tax benefits.

With regard to diversification, after 5 years you have sold 100 stocks, 400 remaining. Start again by balancing out to equal for 500 stocks. There will be tax consequences for the rebalance, but previous losses should help.

When you die, your heirs will be left with the best performing stocks at a higher cost basis.


Craig

Hmm, might this not work out to a portfolio that always did a lot more "sell low" than "buy low, sell high"?
You'd also gradually have a lot less diversification as time goes on, and you'd end up holding stocks for a very long time, which isn't always good.
...
Using GTR1, the bottom 5 1 year return stocks have a negative return for the next 3 months and 2% return for following year. Basically cut losers, allow winners to run and reap the tax benefits.


Hmmm, I'm still a little dubious.
I'd want to see a test of the *specific* strategy proposed before putting money into it.

My concern is that, OK, maybe the bottom 5 are dregs as your test has showed.
But the next 5, and the next, and the next, and the next?
It seems to me that there aren't that many bad companies among the S&P 500. Other than at the extremes, most of them are pretty ordinary.
Absent a specific test, a plausible alternative theory would be that you are forever selling whatever is currently cheap, and keeping whatever is currently expensive.
There will certainly be some of that effect...would it dominate or not? I am unwilling to just guess.

Maybe your strategy is an excellent one, and I certainly haven't tested it.
But it seems like it has perhaps (?) been arrived at by placing tax concerns above return concerns.
That usually isn't the optimal strategy for maximizing after-tax returns.

If one wanted a "drop the losers" strategy, my starting point would be more like this: Keep the best firms based on their [relatively recent] business metrics, not based on their price performance ending at the current price.
If that strategy works (admittedly a big if), you'll be doing sufficiently well over time that you'll be content to pay the higher taxes on it.
I'd rather pay $100 tax on $300 of returns than pay $50 tax on $200 of returns.

Jim

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