One of the most common mantras you hear in investing is diversification. On paper, this makes sense. Don’t put all your eggs in one basket. There is a form of diversification that I do recommend for the majority of individuals. But for the investor with an owner mindset, there’s no need to overdo it.
When To Diversify
Since the vast majority of individuals don’t want to do company analysis or estimate its intrinsic value, they should have their savings parked in index funds. Essentially, this diversification means owning the entire market. Research shows that most “professional” money managers under-perform the market, so why take chances? Indexing takes all the thinking out of the equation, and it’s smart to dollar cost average: Setting aside the same amount of money regularly, regardless of how high or low the market is. In the long-run this will even out, as you automatically buy less when the market is high, and more when its down.
Know What You Own
Imagine you lived in a town where there are 100 businesses. Do you want to own all of them? Instead, how about owning the top five? If you own the best five, what do you need diversification for? If you know what you own, like the management, its competitive positioning and the price you paid, why would you overly diversify? Obviously you do need to watch your egg basket and follow its development. You may love your stock for plenty of reasons, but the stock doesn’t know you own it and has no feelings for you. If there are serious negative developments in the firm’s fundamentals, don’t hold on to it.
Remember that the business must first be in your circle of competence before you invest. If you own 30 stocks, can you honestly say you know company number 30 as well as you do companies 1-5? Are you that good a stock picker that you can identify 30 superior businesses with the criteria listed in the first paragraph? If you can, you are probably an outlier and there’s no need for you to be reading this blog in the first place. If you invest using the punch-card mental model, 20 businesses over an investing lifetime is more than you need in order to do very well.
The good news is that you don’t have to understand every business out there. The hard part is not knowing when to swing, but having the patience to wait for the perfect pitch. You’re bombarded with investing ideas with persuasive reasons to give up your hard earned money. The street makes its money from activity (transaction costs). You make your money through inactivity. Don’t let FOMO lure you into doing something you might regret. Usually if an investment is being sold to you, more often than not its great investment merits and future is already reflected in its price. Remember, we want to buy companies for less than their worth, not more.
Conclusion
- If you wan’t an easy way to invest and you’re not interested in analyzing companies, put your money into index funds.
- If you wan’t to pick stocks, adhere to mental models and be patient.
- Fight your nature by not giving up to FOMO.
-IGTSKasimir
Further Reading
Warren Buffett – The Partnership Days (1956 – 1969)
Philip A. Fisher – Lessons From The 15% Man
The Best of Ben Graham – Security Analysis
Phil Town – The Compounding River Guide
Margin of Safety – The Most Important Thing
Intelligent Investing = Thinking In Probabilities
The Emotional Stages of a Value Investor
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