Overdiversification Question

[ANP301191]

Question - how many positions is too many positions?

 

I know there is a mathematical point of view where between 15-25 stocks may be creating too much diversification leading to diminishing returns. But this is more of a mental space question.

 

I am not a full time investor and while I enjoy investing and learning about businesses, it is very much a thing I do after my 9-5 job. Until I got married and had a baby, I had more than enough time to fully analyze 10-20 ideas, build out some sort of thesis and monitor the investments. Since the changes in my personal live, I have had less and less time to actually spend on my investing. This led to some horrible positions in the last couple of year which not only didnt work, but the thesis behind them was materially flawed when I reviewed them later on. In fact, if I had only kept my top 7/8 ideas and allocated capital only to those ideas, my return would be up another 10-12% vs what I achieved over the past 2 years. So trying to figure out whether there is any value to keeping a portfolio of 15-16 positions that I have today (spread over 12 different ideas) or whether it is better to go to my top 5-6 ideas and allocate more capital there.

 

In all honesty - I am young enough to take larger risks as I still have 30-35 years to work before retirement and I don't really need the capital I have invested for any major expenses for the forseeable future.

 

Thanks for the insight - and sorry if this question was raised elsewhere, couldnt find a similar thread.

 

 

[coffeecaninvestor]

4 hours ago, ANP301191 said:

Question - how many positions is too many positions?

 

I know there is a mathematical point of view where between 15-25 stocks may be creating too much diversification leading to diminishing returns. But this is more of a mental space question.

 

I am not a full time investor and while I enjoy investing and learning about businesses, it is very much a thing I do after my 9-5 job. Until I got married and had a baby, I had more than enough time to fully analyze 10-20 ideas, build out some sort of thesis and monitor the investments. Since the changes in my personal live, I have had less and less time to actually spend on my investing. This led to some horrible positions in the last couple of year which not only didnt work, but the thesis behind them was materially flawed when I reviewed them later on. In fact, if I had only kept my top 7/8 ideas and allocated capital only to those ideas, my return would be up another 10-12% vs what I achieved over the past 2 years. So trying to figure out whether there is any value to keeping a portfolio of 15-16 positions that I have today (spread over 12 different ideas) or whether it is better to go to my top 5-6 ideas and allocate more capital there.

 

In all honesty - I am young enough to take larger risks as I still have 30-35 years to work before retirement and I don't really need the capital I have invested for any major expenses for the forseeable future.

 

Thanks for the insight - and sorry if this question was raised elsewhere, couldnt find a similar thread.

 

 

I’m in a similar life position so I’m curious to see what others think. 
 

I’ve recently moved to 20-25 positions, but am quickly learning that the amount of time I have to research that many investments deeply is impossible with how much free time I have. I plan to over time reduce that number some. 
 

In my opinion I think the sweet spot is probably 10-15 positions and spending more time researching new investments and less time following stocks you already own.  Which means focusing on good businesses you feel like you can hold for a long time is probably a must. 

[LC]

For most people they are 100% concentrated in a single stock, which is the company that employs them. 

Most 'business owners' own a single business. The next bracket probably owns 2-3 businesses.

 

Yet fund managers need 30, 50 positions?

Anything over 3 businesses is just mental masturbation! 

[Milu]

2 hours ago, coffeecaninvestor said:

I’m in a similar life position so I’m curious to see what others think. 
 

I’ve recently moved to 20-25 positions, but am quickly learning that the amount of time I have to research that many investments deeply is impossible with how much free time I have. I plan to over time reduce that number some. 
 

In my opinion I think the sweet spot is probably 10-15 positions and spending more time researching new investments and less time following stocks you already own.  Which means focusing on good businesses you feel like you can hold for a long time is probably a must. 

Same for me, investing is my hobby outside of my normal 9-5 job. A max of about 10 positions is about all I can manage, if I accumulate more than that my brain sees too much clutter and needs to simplify. 
 

My top 4 positions are about 60% of the portfolio.

Edited January 14 by Milu

[coffeecaninvestor]

54 minutes ago, LC said:

For most people they are 100% concentrated in a single stock, which is the company that employs them. 

Most 'business owners' own a single business. The next bracket probably owns 2-3 businesses.

 

Yet fund managers need 30, 50 positions?

Anything over 3 businesses is just mental masturbation! 

Personally I would be willing to let positions grow to this size of a portfolio, but having 3-5 positions at cost was a little difficult for me mentally. 

[UK]

This is really personal, and one has to find what he is confortable to sleep well with. But for me perhaps >10 would be too much. I can manage to go up to 6-8 (7 is actually also has some theorethical reasoning), but in fact usually stay even <6. I also maintain "one" position up to 20 per cent for lower conviction, more speculative bets (could be 5 to 20 names). I think 6+ is more than enough for a diversification. Historically for me concentration grew up with time, experience and AUM. I am quite sure this is a way to improve you results because of the focus and necessity to know more what you are doing. Few times I also went as far as 50+ in one position, but at this time I try not to do this as much as possible:)

 

Edited January 14 by UK

[UK]

1 hour ago, LC said:

Anything over 3 businesses is just mental masturbation! 

Well, this is interesting take

[villainx]

I feel like you want to say 6 7, but don't want to perpetuate that meme.

 

=P

[LC]

19 minutes ago, UK said:

Well, this is interesting take

 

Admittedly a little cheeky as I can't even take my own advice. I've got two big positions (Fairfax, Aecon), four positions between 2-5%, and then a bunch of little 1% or less positions. I figure I'm halfway there and if I can decide what position to become #3 and/or #4, then I can reduce a lot of those small positions.

[Longnose]

I am in a similar situation.

 

And last year i realized with 15 or so positions that when things would win. It didn't really matter to the whole portfolio.  Then one night i flipped open my copy of poor charlies almanack and landed on this page. 

 

 

During the next week i narrowed down my highest convictions bets and now I intend to run 2-3 at most 4.  positions until i feel I hit a threshold / age where I feel preservation is more important than growth.  In theory Id like to say I have the stones to find a few of those wonderful companies that I can just "never" sell.  But early in Charlie and Buffets careers they definitely traded more than the HODL mantras they use now that they have larger sums. 

 

 

[UK]

21 minutes ago, LC said:

 

Admittedly a little cheeky as I can't even take my own advice. I've got two big positions (Fairfax, Aecon), four positions between 2-5%, and then a bunch of little 1% or less positions. I figure I'm halfway there and if I can decide what position to become #3 and/or #4, then I can reduce a lot of those small positions.

Yea, I do not disagree with you:). I feel this way with mine 'basket' positions and either they have to grow up to something biger, or afer some time I just clean them, sometimes everything, especially if can not have a full attention to my portfolio.

[Red Lion]

I think there's a case to be made for a concentrated portfolio while still maintaining differing exposure to non correlated sectors. I don't mean this in the sense of having equal exposure to all different sectors/markets. I think you could have things like big tech, railroads, residential real estate, insurance holdcos, tobacco, healthcare, credit rating agencies, alternative asset management, insurance brokers, stock market exchanges, and utilities and still get a lot of benefits from diversification without actually mirroring the value of the publicly traded universe of investments. 

 

So for example, let's say you want to have a 10 position portfolio with no more than 20% exposure to particular risk profile (sector, interest rate risk, etc.)  and perhaps you have a very strong grasp on insurance holding companies, railroads, and tobacco. 

 

Does this mean you go out and pick 7 stocks in 7 different areas you aren't an expert on? Or could it not then make sense to make basket type positions in areas where you want exposure, but don't have a strong opinion about the individual company with the best long term prospects. Maybe it makes sense to buy a basket of 20-30 Japanese stocks for example, or medical devices companies, etc. 

 

I recently wanted to start a position in the Insurance Brokers, but am still coming up to speed on the companies, and will probably continue to come up to speed for the next several years as I watch them execute their business plans. So I'm splitting my allocation between BRO/AGJ/RYAN. I've done this before with alternative asset managers and tech companies. I think I'll be taking more moves like this over the coming years as I plan to move a lot more of my invested capital into the equity pile.

 

This basket type approach can also provide a nice way to do some tax loss harvesting while slowly identifying the winners in different categories. 

[73 Reds]

3 minutes ago, Red Lion said:

I think there's a case to be made for a concentrated portfolio while still maintaining differing exposure to non correlated sectors. I don't mean this in the sense of having equal exposure to all different sectors/markets. I think you could have things like big tech, railroads, residential real estate, insurance holdcos, tobacco, healthcare, credit rating agencies, alternative asset management, insurance brokers, stock market exchanges, and utilities and still get a lot of benefits from diversification without actually mirroring the value of the publicly traded universe of investments. 

 

So for example, let's say you want to have a 10 position portfolio with no more than 20% exposure to particular risk profile (sector, interest rate risk, etc.)  and perhaps you have a very strong grasp on insurance holding companies, railroads, and tobacco. 

 

Does this mean you go out and pick 7 stocks in 7 different areas you aren't an expert on? Or could it not then make sense to make basket type positions in areas where you want exposure, but don't have a strong opinion about the individual company with the best long term prospects. Maybe it makes sense to buy a basket of 20-30 Japanese stocks for example, or medical devices companies, etc. 

 

I recently wanted to start a position in the Insurance Brokers, but am still coming up to speed on the companies, and will probably continue to come up to speed for the next several years as I watch them execute their business plans. So I'm splitting my allocation between BRO/AGJ/RYAN. I've done this before with alternative asset managers and tech companies. I think I'll be taking more moves like this over the coming years as I plan to move a lot more of my invested capital into the equity pile.

 

This basket type approach can also provide a nice way to do some tax loss harvesting while slowly identifying the winners in different categories. 

I think it depends mostly on your level of knowledge and experience and where you are at in life.  I mean look at what the standard is in the money management industry - 60/40 stocks and bonds.  Just who is that appropriate for?  Going beyond that, they tell you it is all about each individual's risk tolerance.  Well, unless you are well versed in finance and investments, how do most people even know what their risk tolerance really is in relation to the universe of investment assets?   Any one asset class may be deemed "risky" by itself but combined with other asset classes does this change the risk profile?  Then, once you achieve a certain point in life, be it retirement, success, quality of life, etc... it is very likely your investment mix may change yet again.  For me there is an additional element that pretty much trumps everything else; that is the level of control over any investment.  Because of the importance of this single factor, a public equity needs to surpass a very high hurdle rate for me to have any interest at all.    

[dwy000]

About 10 years ago my wife got fed up and implemented a rule for everyone in our house that when it comes to new clothes:  one in one out.  Any new clothing addition (even gifts, if kept) had to be offset with the donating of a similar item to charity.  At first I was skeptical but I've come to love the discipline.  There are lots of things I see and want but then I have to think - is it worth getting rid of something I already have.

 

Ive found it to be an even better rule for investing.  I have a hard limit of 15 stocks and anything new requires a disposal of something else.  And this is especially hard because I have about 5 stocks that I've had for 10-15 years that are almost entirely capital gains right now so I cant get rid of them. 

 

Concentration is wonderful if you pick the right 3 stocks. Its terrible if you pick the wrong ones.  And even the right ones can underperform for many years so you dont know for a long, long time.  Theres no right answer.  Do what makes you comfortable and so you can sleep at night and look forward to checking the market after work.  

[Longnose]

14 minutes ago, dwy000 said:

About 10 years ago my wife got fed up and implemented a rule for everyone in our house that when it comes to new clothes:  one in one out.  Any new clothing addition (even gifts, if kept) had to be offset with the donating of a similar item to charity.  At first I was skeptical but I've come to love the discipline.  There are lots of things I see and want but then I have to think - is it worth getting rid of something I already have.

 

I like this. I need to adopt it today.

[dwy000]

12 minutes ago, Longnose said:

 

I like this. I need to adopt it today.

For clothes or stocks?

[Gregmal]

4 hours ago, LC said:

For most people they are 100% concentrated in a single stock, which is the company that employs them. 

Most 'business owners' own a single business. The next bracket probably owns 2-3 businesses.

 

Yet fund managers need 30, 50 positions?

Anything over 3 businesses is just mental masturbation! 

Yup. Been rocking core 4 or 5 as like 80-100% of the portfolio and then using ~30% or so of margin to play smaller stuff. Dont know why anyone would waste time doing fundamental analysis to own a bunch of 5% positions, assuming those 5% positions are considered "full". So much easier to own the index...but then you get folks who still wanna get outwitted by Mr Market and own the index minus all the best stuff, so who knows?

[coffeecaninvestor]

8 minutes ago, dwy000 said:

For clothes or stocks?

I’m going to add kids toys to this. 

[John D. Rockefeller]

Personally for me 2-3, at an absolute maximum 4 stocks. I find it difficult to find good companies cheaply

[whatstheofficerproblem]

To invert this, how little is too little? 90% of my portfolio is in one stock with the remaining 10% in the LEAPS for same name. Am I underdiversified?

Edited January 14 by whatstheofficerproblem

[villainx]

2 minutes ago, whatstheofficerproblem said:

To invert this, how little is too little? 90% of my portfolio is in one stock with the remaining 10% in the LEAPS for same name. Am I underdiversified?

 

depends how high that one stock goes.

 

[thepupil]

my biggest stock* is 12.5% of my portfolio and 7% of my net worth. I'm long 18-20 issuers, but far more underlying companies and assets on a look through basis, and like 5 indices via 401ks and also have 1/3 of my NW in a trust i don't control that's in indexes.

 

also my 2 largest positions are a) a bank that is basically a levered bond portfolio and b) a bank that's an equity / bond closed end fund in disguise. 

 

I have generally gotten more diversified over time. i occasionally have high conviction in something and am unafraid to swing hard if I think it's worthwhile to do so. my two biggest positions were initiated in the past 2 years at 10-15% at cost..i used to carry 30% positions but that did not really help and i think caused more harm than good. If I was excellent at analyzing very high quality unlevered assets and could predict the future better, I'd be more concentrated.

 

I am a renter of conflicted holdco's and mediocre REITS. most things i own have some kind of governance or leverage tail risk that I am aware of and don't wish to have several or many years savings of exposure to. a permanent impairment on a 20% position would take me 2-4 years to save back. with that said, my biggest loss ever is 600 bps and I probably am being too conservative as that was on a much bigger position than i have now. I don't really recall other losers >200 bps, but am sure there have been some...it's been a forgiving bull market. I generally find that my investment ideas are all the same degree of mediocre and saying that I KNOW which ones are the "best" is not intellectually honest. I do this part time and there's always like 10 things that with more time I'd want to diligence with each investment. Even then that'd probably only increase the illusion of knowledge and control. 

 

this is very individual and case specific. I put 100% in the first stock i bought and it went to $0. That was $4-$8K (long time ago cant remember). made that back completely with my first job's signing bonus. I had 100% positions in my IRA for a few years after that...mostly worked out very well...a 100% position gone wrong today would undo 15 years of work saving and investing, a wholly unacceptable outcome for me and my family. 

 

*excluding ALEX which is different because that is hedged / financed and will become cash in 0-2 months

 

 

Edited January 14 by thepupil

[LC]

33 minutes ago, John D. Rockefeller said:

Personally for me 2-3, at an absolute maximum 4 stocks. I find it difficult to find good companies cheaply

 

Would you be comfortable sharing what makes up your portfolio? High conviction ideas are good research opportunities, IMO.

[sholland]

“With each investment you make, you should have the courage and the conviction to place at least ten percent of your net worth in that stock.” - Warren Buffett 

 

If you are not willing to put at least 10% into an idea then the margin of safety is too narrow.  That philosophy means a maximum of 10 stocks.

[Red Lion]

2 hours ago, 73 Reds said:

I think it depends mostly on your level of knowledge and experience and where you are at in life.  I mean look at what the standard is in the money management industry - 60/40 stocks and bonds.  Just who is that appropriate for?  Going beyond that, they tell you it is all about each individual's risk tolerance.  Well, unless you are well versed in finance and investments, how do most people even know what their risk tolerance really is in relation to the universe of investment assets?   Any one asset class may be deemed "risky" by itself but combined with other asset classes does this change the risk profile?  Then, once you achieve a certain point in life, be it retirement, success, quality of life, etc... it is very likely your investment mix may change yet again.  For me there is an additional element that pretty much trumps everything else; that is the level of control over any investment.  Because of the importance of this single factor, a public equity needs to surpass a very high hurdle rate for me to have any interest at all.    

 

I think I find myself in the category you describe where my investment mix may be changing yet again. Mostly due to success and quality of life concerns. Much like you, I've built the vast majority of my wealth with investments where I have control, and that's still where the majority of my net worth lies. But I actually love the idea of more passive ownership in great businesses where I don't need to exercise control. Obviously this has pitfalls, and I think diversification is helpful in this regard. I'll never have control, or input even, into the performance of my equity investments. JOE is the closest thing I have to a small cap right now. 

 

My goals for 5 years are to be up to about two thirds in passive investments (no control other than investment selection). Ideally with a tax efficient setup (holding big winners for a long time and recycling losers) and minimal blowup risk. If I can beat inflation by 3 or 4% over the long run, I'd be happy with that (and even 60/40 often performs this well I believe). This isn't to say I want to be an index investor, I still like active stock selection, but investment goals will change depending on circumstances. I'd like to be able to live a nice life for as long as possible off of my investments and still leave a larger inflation adjusted portfolio than I have now. When reaching that goal I don't think it makes sense to have 50% of my net worth in one investment I think is going to do 20% a year. But let's say I had 2X the assets necessary, why not?