Is Concentration a better strategy than Buy and Hold?

[ValueArb]

I’m a value investor, so I can’t comment on “buy and hold” investing,  as I don’t understand what that is. 
 

Concentration is a pretty simple concept for value investors. This means you understand how to estimate intrinsic value, only buy with a large margin of safety, stay within your circle of competence, and demand a moat or at least a catalyst. If you do those things not concentrating is an expensive mistake.

 

This is because you should have no problem ranking investments in terms of likely returns and risk. So why would you put some of your portfolio into a 20th or 30th best idea instead of your five best ideas? You would be reducing your returns.

 

And you would be increasing risk. The fewer positions you hold the better you know them and their risks. You will never understand 20 or 30 positions as well as you can 5 or 10. Volatility is not risk, but even if it concerns you volatility of an uncorrelated ten position portfolio is not much more than a 30 position portfolio.

 

Lastly, if you don’t understand how to value well enough to rank, you should not be buying individual stocks. Nothing wrong with index funds.

[mattee2264]

I think a healthy dose of humility is needed.

 

If you look at the "best ideas" of professional investors even those with good track records eg as found in Outstanding Investor Digest/Value Investor Insight/Sum Zero/ Roundtables of the various magazines like Fortune/Barron's and hedge fund letters and then see how they worked out a few years down the line the results tend to be mediocre at best. 

 

Also even Buffett & Munger freely admit most of Berkshire's wealth comes from a few investments. And part of their genius and an essential factor in a concentration strategy is that when they get it wrong which is often they rarely lose much and then when they get it right they let their winners ride.

 

Also goes without saying that often returns and risks are often correlated and in mostly efficient markets they usually are

 

LOW RISK LOW RETURN. As a reductio ad absurdum example you could go 100% into Treasuries. Concentrating in bond like proxies and certain types of real estate gets a similar result but because of leverage (which done well can greatly magnify returns without resulting in too much risk in most normal environments) this can be quite a good way to make money in real estate. 

 

MEDIUM RISK MEDIUM RETURN. This is where most professional investors settle and end up with market type returns regardless of how concentrated they are but with greater volatility of returns if they do concentrate 

 

HIGH RISK HIGH RETURN. These kind of bets can make hedge fund reputations and also make amateur and professional investors think they are the next Buffett but often lead to overconfidence and blow ups. Note that there are deep value type investments where if things work out you get a ten bagger and if they don't you get a zero but with these special situations you need to keep position sizes small and pick your spots carefully. 

 

LOW RISK HIGH RETURN. This is the holy grail but much harder to identify than you'd think. 

 

And also to really judge a strategy and your success in implementing it you need to have experience of a proper bear market as well as a long bull market and a lot of amateur/professional investing careers only date back over the last decade when concentrating in quality growth (with Big Tech the obvious example) was the winning strategy. I cannot say with the same confidence that quality growth investing will do so well over the next decade and may well lag the market significantly especially if you concentrate in companies that confronted with the test of time turn out not to be as nifty as originally believed. And to some degree we've already seen that to some degree with the FANG stocks. 

 

 

 

 

 

Edited March 26, 2023 by mattee2264

[Cod Liver Oil]

@dealraker it may be sacrilegious to Buffett for you to call out Apple, but no one else cares. You are an elder statesman here and won't get crap from us. It makes sense that we are at peak Apple and it should revert to the mean. I remember Buffett's chart of the largest companies in 19XX;  20 years later, none were on the list. If you were referring to another big tech company, never mind.

But it would be fun to hear why you think GOOG may not be subject to the same gravities.

 

Edited March 26, 2023 by Cod Liver Oil

[gfp]

4 hours ago, dealraker said:

There is one stock in technology and other businesses that I think gets a very special treatment

 

It's funny, and I guess it reveals our internal biases to some degree, that Cod Liver Oil thought dealraker was referencing Apple while I read the same post and immediately assumed he was referencing Tesla.

Edited March 26, 2023 by gfp

[jfan]

58 minutes ago, Munger_Disciple said:

 

  This is a great post. Survivorship bias is a real problem with the concentration strategy and it won't work for most people. It takes a unique skill and temperament to succeed at it (Munger, Buffett). It is worth remembering that even Munger & Buffett's buddy Rick Guerin blew up with this strategy even though he somewhat partially recovered from it with his real estate investments.  We only see mostly the successes resulting from the strategy but never the huge number of blowups. Even Buffett & Munger are hugely diversified later in their life through their ownership of Berkshire which owns a variety of businesses. 

Agree with @Spekulatius and @Munger_Disciple. Speaking for myself, I'm definitely a below average investor and would have likely did better just investing in a few indices. Perhaps I am just stubborn and hold some eternal hope that self-improvement is possible, and that even an average Joe could achieve some degree of investment success over time.

 

I think an investor needs to earn the right to concentration because concentration requires 2 important attributes: 1) correctness of your variant view AND 2) ability to change your mind with new information. If you can ingest large volumes of information at great velocity, have great analytic horsepower, and have the ability to change your priors with new information and act on your posterior probabilities quickly and decisively, concentration makes a lot of sense. The unfortunate thing is that most of us have difficult to do this. There is a particular danger confusing correlation with causation as it pertains to concentration and investment success.

 

The risks of concentration also dependent on age and future earning potential. This is counter-balanced with the fact that often wisdom and tacit experience comes with time. 

 

Swing/Value trading even with a 5+ year time frame for the average Joe is really difficult. Getting all the following right is a herculean task: 1) valuation accuracy 2) correct read on the business fundamentals 3) the right gut feeling/judgment of the people involved and 4) timing of catalysts.

 

Hence  @dealraker idea of letting life happen with long holding periods of productive businesses +/- averaging down smaller quantities over time after familiarity in the name builds up, is much more achievable (As long as one is willing to roll up your sleeves to read and learn about the business). The beauty of this approach is the humility in admitting that you don't have to be perfectly correct on the above 4 factors. This limits the impact of any bad investment decision and relies on a bit of luck in finding that wealth-contributing compounder to do its thing reinvesting in itself over time. Will concentration occur in this type of portfolio? I don't have the data, but given the opportunity, my guess is that a portfolio will behave with power law dynamics, but in this latter case, the business earns its way to portfolio concentration. It makes intuitive sense that if I can't maximize any informational or analytic advantage, taking an extreme behavioral strategy (especially if my investment returns don't dictate my employment status) is the only advantage retail investors can capitalize on. 

 

The key I guess is that with a @dealraker approach, is narrowing your field of view to productive profitable businesses with quality long-duration assets. If you can get great capital allocators that is a bonus. Perhaps the only variation I could think of is taking the occasional swing at some very asymmetric bets especially if the risk of a zero is unlikely. 

 

So for me, a buy and hold strategy makes more sense to me than concentration. I'm a slower learner and reader and can't change my mind quickly. Having 1-5% position sizes makes sense. Following ~20-30 positions will allow me to do some semi-regular diligence with an element of benign neglect as long as I stick with more liquid, > mid cap + companies, have a good opinion of management, can grasp at least the rudimentary key drivers of the business fundamentals, as well as favor long-duration quality assets.  

 

I like @Viking approach of asking oneself of how large a % do I want to make this? How sure am I of this mispricing? How familiar am I with the nuances of this business? What is the certainty I have around the valuation ranges? Is there alot of uncontrollable/hard to predict elements that necessitate a more gradual approach (eg land development timing, emerging market sentiment changes, etc). 
 

I finished a night shift last night, so I apologize for the rambling.

 

 

 

 

 

 

 

[rohitc99]

3 hours ago, Munger_Disciple said:

 

  This is a great post. Survivorship bias is a real problem with the concentration strategy and it won't work for most people. It takes a unique skill and temperament to succeed at it (Munger, Buffett). It is worth remembering that even Munger & Buffett's buddy Rick Guerin blew up with this strategy even though he somewhat partially recovered from it with his real estate investments.  We only see mostly the successes resulting from the strategy but never the huge number of blowups. Even Buffett & Munger are hugely diversified later in their life through their ownership of Berkshire which owns a variety of businesses. 

+100

imagine a young munger going all in on BABA. we may have never heard of him in the alternate universe

[Masterofnone]

I had limited time, skills and experience when I first started investing. Like many here, learning about Buffett and Berkshire just resonated. The rationality, downside protection and internal diversity made it the standard against which any other capital allocation was judged. I knew I was dumber than Buffett and just piled on whenever it seemed relatively cheap. Was up to 90% at one time. But Berkshire is unique and it is the only security I'd ever recommend to someone who asked. (because of that downside protection- the quote might get cut in half but the businesses....) Would that work for a new investor now? Hard to say with Buffett unlikely to be at the wheel for a new person's horizon.

 

That said, in an area where you have special expertise and you see an opportunity, why not dive in? what good will it do you to invest by the teaspoon if you truly have a good idea? Trouble is, new investors seldom really have special expertise. I happened to sell my little business toward the start of the pandemic. We were having a spectacular season of sales. Took the proceeds and invested in a public company in the same line of business. Kept the concentration even after the stock popped because I have long experience in the industry and feel comfortable with the future. But with most areas, the future is full of perils and you really have to have LUCK on your side.

[SharperDingaan]

Concentration doesn't just increase gain, it increases loss as well.

Most cannot deal with it. 

 

Buying 2 $10 shares, then selling 1 at a double ($20) is about controlling loss.

If the 1 share stub suddenly drops to $0 the day after your sale, you still have your original $20 investment. Of course the reality is that you would sell well before then; if that 1 share was ultimately sold at $12 (40% less than the earlier $20 sale) - you would still be up 60% on your original $20 investment. 

 

Shoveling money into treasuries is about building liquidity, against the day you fail.

The $20 proceeds on your first 1 share sale going to treasuries, the proceeds on your second 1 share sale funding your next investment. Sell > $20 and it is all sweetness and light, sell >10 and <20, and you need to borrow against the treasury to maintain your next investment at $20. If the shares drop to $5 the day after you buy them (ie: you failed); the treasuries keep you alive until you can eventually sell without incurring a loss. Could be weeks, or even years.

 

The bigger the treasury stack, the more 'staying power', and the more opportunity.

The now $5 share has a cost base of $10/share. However if you could double your position, the cost base would fall to $7.50 and you would be able to both get your money back earlier, and retain a bigger stub to compensate for the higher risk that you took on. The other very real benefit of a treasury stack ...

 

Control the money, don't be a slave to it.

Continually do well and the treasury stack will grow, but after a while it will become too large for purpose, and cash will  need to be continually withdrawn. Do something positive and life changing with it, either for you or for somebody else; sadly .... a great many just snort it, destroy their families, and would have been much better off had they simply remained poor.

 

SD

 

 

Edited March 27, 2023 by SharperDingaan

[Spekulatius]

@ValueArb I try to answer this. I consider myself a value investor too and buy often things that are out of favor so to speak.

 

There are a couple of reasons why I like to keep more positions around.

1) Some positions are legacy positions and they are holds to me. I wouldn’t  buy them at current prices ,  it I still think they are decent values. Furthermore, they have proven themselves and performed well, So I would like to keep them - maybe trim them but I like to keep a position.

 

An example would be $ORI. I bought it in summer Fall 2020. I felt it was an OK business with some tailwinds to its title business. The execution surprised me to the upside and managment has done better that’s I thought and thry distributed way more cash than I thought. It have trimmed the position a bit, but kept most of my shares. I am very reluctant to sell shares.

 

2) Some bets are “theme” plays where I believe a sector may be undervalued. Let’s take a concrete example and look at the issues in the banking sector. But what’s the best play? there clearly is some tail risk here. I guess I could just bet on one and cross my fingers. Or I could buy an index and call it a day. My preferred approach would be to buy a few banks that I think are money good and hey some diversification.

 

3) I think you don’t know the stock really well before you own them. There are a couple of reasons for this. One of them is that having money at stake sharpens your sense. But there is a more profound  reason: If you buy a stock your research is Post fact um so to speak. Everything seem to make sense as to how things has evolved in the past, at least if you decided to make a buy decision. But when you buy this stock and things start to evolve and new issues come up, Management decisions can flabbergast you. I often  find that I don’t know the business as well as I thought and I think buying a new  stock is inner Italy much riskier than holding one, from my POV. This even more so if you make contrarian bets as you often do as a value investor. So even if your research a stock , you know less than you think and also let’s not forget, that luck plays a role here too. For me, it lead to tossing out a lotmof position after a relatively period of time (and often losses).

 

The situation is sort of like reading about the GFC and living through it as an investor. When you read about it now, of course you know the outcome and the outcome makes perfect sense. You were fine , if you held your stocks a couple of years (unless they were in a permanently impaired group like banks). but that’s all post factor. It did not feel that way when living through it, it probably felt more than the people who loved through the depression in the 30’s which of course had a much worse outcome. That's how it is with researching a stock and owning it as well, I think.

 

4) Sometimes when I research stocks, I come across one that I really like (management, business quality) but they are not particular cheap but neither egregiously expensive. I think they are great companies, I like to buy a small position in the with the intent of perhaps buying more later. That also goes along with 3) where I think I know the stocks better that I own, even in small size.

 

Recent examples of above are $BRO ( inspired by @dealraker and $PAYC which is an unusual tech company I found through Motley Fool )

 

5) I believe luck plays a bigger role than most investors give it credit for.

 

Edited March 26, 2023 by Spekulatius

[Cor]

On 3/22/2023 at 8:55 AM, LC said:

Bought a skiing & fishing outfitter, pizzeria & bar, and HVAC commercial route. 

 

I definitely do not run the shop - I had 3 individuals ready to take over (exec sous chef, HVAC contractor, and a fishing/ski guide). All with 10+ years of corporate experience in a larger market (greater denver/front range) who we are able to install running the majority of the operations in a smaller area (mainly summit county). 

 

We bought the outdoor shop and pizzeria at 1-1.5x last year earnings. The HVAC we bought the existing book of business (stable for 5+ years) for 2x earnings. 

 

All 3 operators get to move to summit county under workforce housing (less housing expense for them), earn more $, and run their shop with partial ownership (and some oversight).

 

The ski shop is a bit key-man risk as the guide business will probably be a wash: old customers may fall off but our operator will bring his book of business from the front range area. The pizzeria/bar looks very good as the old owner/operator has no actual chef and also was running 3 different foodservice businesses so didn't really have the time to dedicate to it. New operator will be able to improve the menu (see: add salt), expand hours, and manage more events/catering. The HVAC business we bought a commercial book which should remain stable as the old owner will stay on for 6 months, new operator can manage a separate crew for residential runs, and I know a few multifamily developers in summit/grand county who will give us their HVAC business (and also run their catering through us, and provide cheap housing for the 3 new operators). 

 

As a kicker both the outfitter and pizzeria have a surprising amount of cash sales which the prior owners pocketed - so when I say I bought at 1-1.5x earnings, it's even cheaper as there are cash sales unaccounted for. When I bought I just considered it a wash: any cash sales were zero margin and just went to the operator as their "salary". In reality that's probably not the case and should provide additional earnings. Just provides some margin of safety.

LC: Very interesting read, thanks for sharing your experience. I always wondered how these sorts of deals get done when a small business exchanges hands. If you are comfortable sharing, I’m curious about the pizza shop because you mentioned the old owner seemed spread thin between running it and their other businesses. Was this a find through your existing network or a targeted search of some sort? Sounds like a great opportunity for you, congrats! 

[LC]

All 3 really came from friends - coincidental they happened around the same time.

 

the pizza joint specifically, a year back my buddy was hired as a executive chef/GM at a local restaurant group, managing 2 locations. Well, the owners and existing management oversold his role and so frustrated, he quits and decides to spend the rest of the winter skiing. Calls up his friend who owns this pizza shop near the mountains, and asks if he can work some shifts after skiing during the day.

 

well, turns out she’s looking to sell and asks if he wants to buy it. So he calls me, I manage the acquisition and here we are. We got the inside scoop before she listed it, bought for a friends discount as well.
 

She owns 2 other bars and is building some mini casita/ bar&restaurant down in Mexico - needed cash quick and can’t spend any time in Colorado managing a pizzeria and 2 bars when she is trying to build out a tiny villa from scratch on empty land.
 

I tried to buy the bars as well but those as you can imagine are her cash cows and easier to manage - she wasn’t selling.

 

other 2 ventures are similar in that I knew folks for a few years looking to make a change, we figured out a way to do it profitably for all parties. 
 

That’s why I try to never turn down drinks!

[Stuart D]

12 hours ago, rohitc99 said:

+100

imagine a young munger going all in on BABA. we may have never heard of him in the alternate universe

 

 

Yes, I think the same (would we know Munger's name?) if the below merger-arb fell through.

 

From the Snowball:

"Munger did enormous trades like British Columbia Power, which was selling at around $19 and being taken over by the Canadian government at a little more than $22. Munger put not just his whole partnership, but all the money he had, and all that he could borrow into an arbitrage on this single stock."

[Spekulatius]

43 minutes ago, Stuart D said:

 

 

Yes, I think the same (would we know Munger's name?) if the below merger-arb fell through.

 

From the Snowball:

"Munger did enormous trades like British Columbia Power, which was selling at around $19 and being taken over by the Canadian government at a little more than $22. Munger put not just his whole partnership, but all the money he had, and all that he could borrow into an arbitrage on this single stock."

Munger has a way way higher risk tolerance than Buffett. Buffett also took some chances early on, but never to the same extend than Munger did. Buffett also was actively involved as a control investor when he bet big. He left up as little as possible to chance and other people. I don’t think Munger ever did that either.

[Castanza]

7 hours ago, LC said:

All 3 really came from friends - coincidental they happened around the same time.

 

the pizza joint specifically, a year back my buddy was hired as a executive chef/GM at a local restaurant group, managing 2 locations. Well, the owners and existing management oversold his role and so frustrated, he quits and decides to spend the rest of the winter skiing. Calls up his friend who owns this pizza shop near the mountains, and asks if he can work some shifts after skiing during the day.

 

well, turns out she’s looking to sell and asks if he wants to buy it. So he calls me, I manage the acquisition and here we are. We got the inside scoop before she listed it, bought for a friends discount as well.
 

She owns 2 other bars and is building some mini casita/ bar&restaurant down in Mexico - needed cash quick and can’t spend any time in Colorado managing a pizzeria and 2 bars when she is trying to build out a tiny villa from scratch on empty land.
 

I tried to buy the bars as well but those as you can imagine are her cash cows and easier to manage - she wasn’t selling.

 

other 2 ventures are similar in that I knew folks for a few years looking to make a change, we figured out a way to do it profitably for all parties. 
 

That’s why I try to never turn down drinks!

 

Interesting stuff LC hope they work out well for you. Sounds like a solid deal from being in the right place at the right time. Planning on getting a liquor license for the pizza shop?

[Gregmal]

When you look at people who have really made it, the bulk of the self made did it through ownership of a business or assets. With stocks, both the rich man and the poor man can do this as long as you stick with it, and pick quality. I had several investors back in the day who bought Accenture stock at IPO. Did nothing with it. It was just obvious Accenture was a special business and one you wanted to hold at 10x or 30x. I tend to agree with @dealraker in that you can kinda tell the good from the bad, on average. Is a business or stock popular? Is it near an arms length guess of peak earnings, is it super cyclical or stable, etc. But just like in the thread about the bottom, the impulse is often to overstate the risks. By and large, stocks are the riskiest and most of the reasons arent inherent to stocks. Theyre because of people. AJG is such a good case study of this, and was probably obvious to ole dealraker much more so than he cares to admit LOL. Off the radar, great high margin biz, long runway, few real competitors, etc. None of those items would have told you the stock performance but they all tell you the quality of what you're buying and if the excuse then jumps to "well gee, I dont like paying 15x and 20 is certainly too rich"....well, dont buy stocks. But you have to be in it to win it as they say. Ive yet to meet an 8 figure person who got rich by prop trading small fluctuations with his own money. Ive met several who got there using OPM and many more who owned businesses that catered to people prop trading their own money. 

Edited March 27, 2023 by Gregmal

[ValueArb]

20 hours ago, Cod Liver Oil said:

@dealraker it may be sacrilegious to Buffett for you to call out Apple, but no one else cares. You are an elder statesman here and won't get crap from us. It makes sense that we are at peak Apple and it should revert to the mean. I remember Buffett's chart of the largest companies in 19XX;  20 years later, none were on the list. If you were referring to another big tech company, never mind.

But it would be fun to hear why you think GOOG may not be subject to the same gravities.

 

 

In investing theree is no such thing as reversion to the mean, only reversion to intrinsic value. 

[D33pV4lue]

If you held 10 securities in an equally-weighted portfolio worth $1,000. You believe those securities have a 55% chance to double and a 45% chance to go bankrupt in one year. The expected value from investing in the portfolio is $100 or a 10% return. Now if you came across an opportunity that had an 80% chance to double and a 20% chance to go bankrupt how much of your portfolio would you invest in that opportunity?  

 

This is an extreme example but given the investment options, no one should add the new security at the same weight as the other investments. The caveat is that investors regularly overestimate their edge. What they thought was an 80% probability might only be 60% and resulted in more risk than anticipated. 

 

[LC]

3 hours ago, Castanza said:

 

Interesting stuff LC hope they work out well for you. Sounds like a solid deal from being in the right place at the right time. Planning on getting a liquor license for the pizza shop?

It has a liquor license already. Anyways these are pretty small projects compared to my investment portfolio and equity in the RE I own, and a large part of the reason I'm even involved is to help some friends and tag along on their professional "ride".

 

But I will say it has been much more exciting and grounded to look at these local economics rather than trying to make some guess about recessions and interest rates and the length of the wrinkles on JPow's face QoQ, and whether that means good or bad things for BAC...frankly it's been a bit refreshing.  

Edited March 27, 2023 by LC

[Gregmal]

22 minutes ago, LC said:

But I will say it has been much more exciting and grounded to look at these local economics rather than trying to make some guess about recessions and interest rates and the length of the wrinkles on JPow's face QoQ, and whether that means good or bad things for BAC...frankly it's been a bit refreshing.  

When you think about it, I honestly think this is the difference between the big fish and the little ones. The big ones are busy running businesses or making real world decisions. Gates, Buffett, Musk, Bezos….all the way down to the dealrakers next door, you think they’re doing that nonsense above hoping to scalp 10%? At some point, to get big, your money has to start working for you, rather than you working for you money. And that doesn’t happen when you can’t even decide or commit to where you want to put it, with weekly or monthly fluctuations being difference makers lol.

Edited March 27, 2023 by Gregmal

[Viking]

I think most millionaires in the US got that way through owning their own small business. Is this not an example of extreme concentration? Of putting all your eggs in one basket? Thought exercise: is this really all that different than an investor who highly concentrates in a company they understand very well?

 

The stock investor has many advantages to the small business owner. The biggest is liquidity - if the story gets much worse a stock investor can easily exit the position. When the story improves a stock investor can easily add to the position. 
 

Yes, the business owner also has advantages over a stock investor: usually better information and more direct control over decision making. But the business owner also has many disadvantages: a number of unlikely but possible issues: sudden death / health issues, legal, staff retention, competition etc.

 

My point is lots of people build enormous wealth primarily through running their own small business. That is the definition of concentration. It happens lots. 
 

Yes, diversification (not putting your eggs all in one basket) is a solid objective. However, when the stars align and a wonderful opportunity comes along… concentration makes a lot of sense (as a general principle). The rub - always - is you have to understand the situation exceptionally well. And, like the small business owner, you also have to understand that ‘shit happens’ and you could get wiped out - sometimes for reasons completely outside of your control. Caveat emptor.

Edited March 27, 2023 by Viking

[Gregmal]

8 minutes ago, Viking said:

point is lots of people build enormous wealth primarily through running their own small business. That is the definition of concentration. It happens lots. 

Exactly. And this can be emulated through public markets if you can import the owner/operator mentality and select companies and managements who share your values.

[Munger_Disciple]

2 hours ago, Viking said:

I think most millionaires in the US got that way through owning their own small business. Is this not an example of extreme concentration? Of putting all your eggs in one basket? Thought exercise: is this really all that different than an investor who highly concentrates in a company they understand very well?

 

The stock investor has many advantages to the small business owner. The biggest is liquidity - if the story gets much worse a stock investor can easily exit the position. When the story improves a stock investor can easily add to the position. 
 

Yes, the business owner also has advantages over a stock investor: usually better information and more direct control over decision making. But the business owner also has many disadvantages: a number of unlikely but possible issues: sudden death / health issues, legal, staff retention, competition etc.

 

My point is lots of people build enormous wealth primarily through running their own small business. That is the definition of concentration. It happens lots. 
 

Yes, diversification (not putting your eggs all in one basket) is a solid objective. However, when the stars align and a wonderful opportunity comes along… concentration makes a lot of sense (as a general principle). The rub - always - is you have to understand the situation exceptionally well. And, like the small business owner, you also have to understand that ‘shit happens’ and you could get wiped out - sometimes for reasons completely outside of your control. Caveat emptor.

 

You are right that most are self-made millionaires thru' ownership of businesses in the US. However there is a huge difference between being a private business owner and a passive investor. When you are the business owner, you make all of the important decisions; whether the business succeeds of fails it is 100% on you. When you are a passive minority shareholder you are coat-tailing someone else and hope that the guy in charge is competent, and acts in the best interests of all shareholders. You also hope that the business is a decent one. 

 

I think it is easier to go all in when you are the control owner-operator in a business you truly have an edge. Most people I know took such risks when they were younger. So one might have to concentrate in a private business when he is smart/business savvy, poor & hungry. For most people diversification is the way to stay rich though I would agree that that there might be instances when one might concentrate a bit more. 

Edited March 27, 2023 by Munger_Disciple

[ICUMD]

Black Swan events are the reason I prefer diversification over concentration.

 

Even within a diversified portfolio, I kick myself when one of these events hits a heavy position that I become loathe to average down on. 

 

[Spekulatius]

Saga partner is a concentrated growth fund that had phenomenal performance in 2020 and subsequently lost it all:

https://www.sagapartners.com/_files/ugd/3b0d6d_ce16f046c4524c08893864f3ce87152c.pdf

 

just one example where one bad year wiped out many years of market beating performance. They stopped making their letter public as well.

 

Edited March 28, 2023 by Spekulatius

[Viking]

3 hours ago, Spekulatius said:

Saga partner is a concentrated growth fund that had phenomenal performance in 2020 and subsequently lost it all:

https://www.sagapartners.com/_files/ugd/3b0d6d_ce16f046c4524c08893864f3ce87152c.pdf

 

just one example where one bad year wiped out many years of market beating performance. They stopped making their letter public as well.

 

@Spekulatius i agree highly concentrated portfolios, if given enough time, stand a pretty good chance of blowing up. However, there are exceptions to every rule. 
 

Here is a real life example. Steve Jobs passed away late in 2011. Apple stock did well until Sept 2012 where it peaked out at $25 (split adjusted). But from Sept 2012 to June 2013, Apple stock continued to fall all the way to $14 = 45% decline from its high. Why? The narrative around the company completely changed. Android was generating a lot of buzz. Samsung was riding the wave (holding their own glitzy Galaxy events). And the world decided that with Steve Jobs no longer around that Apple was about to pull a RIM/Blackberry and Nokia and be the next smartphone maker to disappear. 
 

Except Apple’s business was growing like stink… yes, there were ebbs and flows… and the odd mis-step… but the business was growing nicely. Its ecosystem was starting to take hold (IOS and iPods, iPad, iPhone and Macs). I asked my kids… did their network of friends own iPhone’s or Samsung devices? 80% were iPhone (even their South Korean friends owned Apple).
 

Earlier in 2012 we made the plunge as a family into Apple products: Mac - goodbye Intel/Microsoft, multiple iPhones, multiple iPads, multiple iPods. What i learned quickly was the customer service at Apple was exceptional. And the products worked very well - and they worked well together. I started to fully appreciate power of the network effects. 
 

I started buying Apple stock in Q4 2012. And every month the stock kept falling. But my read was the story at Apple was actually getting better. So i kept buying more every month (getting more concentrated). The stock kept falling, the story kept getting better and i kept buying. By year-end i was 100% invested in Apple. 

 

All during this time i was probably spending 20 hours a week researching Apple and the industry. Month after month. 
 

June 2013 was the bottom in the stock. From that point the stock went pretty much straight up for the next 20 months to $33. i did my usual thing on the way up… i lightened up and locked in solid gains.

 

What exactly was the risk i took in Dec 2012 when i went all-in? Was Apple going to blow up like RIM/Blackberry and Nokia? No. Was Android operating system going to replace IOS? No. Was Samsung devices going to replace Apple devices? No. China was also just starting to take off as a smart phone market and the open question was whether affluent Chinese would prefer an American (Apple) or South Korean (Samsung) device as a STATUS SYMBOL. Of course they chose American (understanding a little history helped here). 

What happened with ‘Apple the stock’, was investors temporarily lost their collective minds. From my perspective their are unique times when a concentrated portfolio makes sense. But only for short periods of time. I will admit being 100% invested in Apple did weigh on me at times. 

 

Here is the really interesting thing: If there was a learning from my Apple experience it is probably that i never should have sold a share. I was completely out of the stock by 2016 (right around the time Warren Buffett STARTED buying shares in Apple). Would have delivered me a better return. And saved me a bunch of time. Would owning a 100% position in Apple stock for the past decade really be more risky than owning ‘an average’ small business?

 

Some good did come out of selling my Apple position much too early. I sold Apple because it had gone up a lot in price. Peter Lynch says you should sell a stock primarily because the story changes / gets worse; NOT simply because it has gone up a lot in price. Makes sense. Since selling Apple i think i have been more patient holding winning positions. Fairfax is a good recent example of this - i have owned a core position for about 18 months. Yes, Fairfax stock is way up the past 18 months. But the story has also improved dramatically. 

 

Edited March 28, 2023 by Viking