Why is Warren Buffett such a fan?

Buffett compared owning lots of stocks to owning a zoo. This approach may protect my capital but it won’t necessarily grow it. 

A quick bit of maths bears this out. Let’s say I own 50 stocks. If one of these doubled, it would increase my overall portfolio value by 2%. However, the effect of a single stock doubling naturally has a greater impact using a concentrated strategy. In the same scenario, the overall portfolio value would rise 10% if I owned just 10 stocks.

Clearly, if I were able to repeat this performance over many years, my wealth would multiply far quicker!

In good company

It’s easy to dismiss Buffett’s take on the concentration/diversification debate. Praising the former when you’re already extraordinarily wealthy makes sense. However, he isn’t alone in believing that the best returns come from this strategy.

In his book ‘100 baggers‘, author Christopher Mayer highlights how many of the world’s most successful investors, such as Bill Ackman and Bruce Berkowitz, have only a few holdings. At the time of writing, these people had the equivalent of billions of pounds invested in only their best seven and eight ideas respectively. 

As far as the UK’s concerned, top fund managers like Terry Smith have long praised the concentrated approach. And the performance of Fundsmith Equity speaks for itself! 

So, am I 100% with Buffett?

I don’t agree with Buffett completely. I don’t have money to burn. Nor do I have the same level of experience in the markets as the 90-year-old all-time investing great. To be clear, there are certainly issues with me adopting this strategy.

Perhaps the most obvious is that I might own the wrong stocks. These could tumble on poor trading or even cease to exist! A stock that goes to zero reduces the value of a 10-stock portfolio by 10%. For a 50-stock portfolio, it’s a more palatable 2%. There’s also a psychological benefit of being diversified. A portfolio that keeps me awake at night just isn’t worth bothering with. 

On the flip side, owning a small number of stocks may give me an edge. Since more of my money is invested in them, I’m compelled to be up to date with developments and know why they’re worth holding.

This comes into its own when investing lower down the market spectrum. Many people simply don’t have the time or inclination to thoroughly research market minnows that could generate explosive returns in time. 

Bottom line

To his credit, Buffett thinks most people shouldn’t be concentrated investors. They should just invest in index funds and not try to beat the market. I’m inclined to agree, especially for those who have no interest in stocks.

For more active investors like me however, I think the message needs to be that there’s no ‘perfect’ number of stocks to own. Instead, my portfolio should reflect a sober evaluation of my tolerance for risk. Setting achievable goals is also vital.

Get this right and I could do well, albeit maybe never as well as the Sage of Omaha.

The post Concentration vs diversification: I’m with Warren Buffett appeared first on The Motley Fool UK.

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Paul Summers owns shares in Fundsmith Equity. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Nevertheless, the fact that no one really knows where we’re headed over the short term doesn’t mean that investors can’t take action to ensure they can meet any seismic events with something approaching indifference.

The best way of bulletproofing your share portfolio for 2018? Yes — you’ve guessed it — diversification.

Safety in numbers

For those who prefer to err on the side of caution, can’t follow day-to-day market movements, or have little interest in investing beyond recognising that it’s a great way of growing their wealth, exposure to a variety of stocks makes a whole lot of sense.

One way of diversifying your holdings is through geography — something definitely worth considering with Brexit on the horizon.

Black swan events aside, the important thing to realise is that not all stock markets behave the same. Moreover, the worst performing market one year is often (but not always) one of the best performers in the following year. Emerging markets, for example, lagged pretty much everything else in 2008. In 2009, they were the top performing sector. Exactly the same pattern occurred in 2015 and 2016.

So rather than attempt to predict which will perform best in any one year, it’s worth having exposure to a number of markets. Perhaps the most convenient, cost-effective and least risky way of achieving this is to buy a group of exchange-traded funds or, alternatively, a single global tracker that assigns different amounts of your capital to different areas.

Having made sure that you’re not totally reliant on UK plc, another consideration, as far as equities are concerned, relates to sector diversification. This is important given that some parts of a single market will perform better than others depending on where in the economic cycle we happen to be.

Buying a bunch of housebuilders and very little else is flirting with disaster, particularly if the housing market takes a dive. The same goes for retailers if consumer spending shows signs of slowing. A portfolio composed just of oil stocks won’t do you any favours if the price of black gold tanks like it did a couple of years ago. You get the idea. 

A housebuilder, a consumer goods stalwart, a bank, an energy giant, a miner, a pharmaceutical or two, an engineer, a few tech-related stocks? Now we’re talking.  

One last aspect of diversification worth considering is your approach to investing.

Some market participants like to rigidly adhere to a particular strategy, labelling themselves as growth hunters or small-cap specialists. To muddy the waters, some will label themselves as small-cap growth investors.

Not only is this tendency unnecessary, it’s also potentially bad for your wealth given that certain strategies perform better than others at different times (growth-focused stocks have trumped those offering value in recent years).  As such, those looking for a smoother ride to riches should consider having a mixture of different kinds of companies (large, small, undervalued, new, established) in their portfolios. While less exciting than finding the next Amazon or Apple, your returns should be far more consistent. 

The post How to bulletproof your portfolio for 2018 appeared first on The Motley Fool UK.

More reading

• Why I think the HSBC share price could hit 2,000p by December
• £15,000 invested in UK shares a decade ago is now worth…
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• Prediction: Diageo shares could soar in the next 5 years if this happens…
• With a P/E of 5.9 is this a once-in-a-decade opportunity to buy dirt-cheap easyJet shares?

Paul Summers has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Think long term and be patient

Ever heard the saying ‘Rome wasn’t built in a day’? People often forget that Sir Alex Ferguson, one of the most successful football managers of all time, took four long seasons to win his first trophy. Of course,he went on to win many Premier League titles and countless trophies, but it certainly didn’t happen overnight.

Building a winning portfolio can also take many years of patience and perseverance. Would Sir Alex have had such an illustrious managerial career in this modern age of short-termism? I very much doubt it.

Warren Buffett, hailed by many as the greatest investor of all time, didn’t make his first million until 1962 (aged 31), even though he had been investing since the age of 11. It would be another 28 years before he joined the ranks of the billionaires, and a further 18 years before he became the richest person in the world, in 2008. When it comes to investing, patience is definitely a virtue, and a profitable one at that.

A balanced portfolio

We all know that Sir Alex went on to build many successful Manchester United (NYSE: MANU) teams based around a core of young players. But most people forget that the likes of David Beckham and Ryan Giggs were also supported by more mature and experienced players, including my favourite player of all time, Eric Cantona. Here youthful exuberance was perfectly balanced by the more grounded and experienced Frenchman.

By the same token it would be foolish to build a portfolio solely comprising fledgling companies yet to prove their business model or profitability. I’ve always believed that a good mix of mature and stable blue-chips, along with a sprinkling of more exciting and speculative small-caps provides the best of both worlds. Remember, taking on too much risk can be hazardous to your wealth, and capital preservation is more important than making profits.

Diversification

That brings me nicely on to my last point, diversification. How many football teams can you name that comprise solely 11 strikers, 11 defenders, or even 11 goalkeepers? A solid portfolio needs a good mix of stable, less volatile defensive companies that won’t buckle in times of crisis, as well as perhaps more cyclical companies that perform well during boom times.

Defensive sectors like utilities and consumer goods consistently perform well during the bad times as well as the good, while more cyclical sectors such as housebuilders and retailers ebb and flow in tune with the economic cycle.

Finally, in the interest of fairness, I’d like to point out that other football teams are available to support – although they may not be as good!

The post How football can help you build a winning portfolio appeared first on The Motley Fool UK.

More reading

• Why I think the HSBC share price could hit 2,000p by December
• £15,000 invested in UK shares a decade ago is now worth…
• 3 FTSE shares with many years of consecutive dividend growth
• Prediction: Diageo shares could soar in the next 5 years if this happens…
• With a P/E of 5.9 is this a once-in-a-decade opportunity to buy dirt-cheap easyJet shares?

Bilaal Mohamed has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Buying the whole market

There are over 600 companies in the FTSE All-Share Index, representing 98% of the market capitalisation of businesses on the London Stock Exchange. You’d need a sizeable sum to invest in all of these companies individually, due to dealing costs. However, even with a mean budget, you can buy a low-cost fund that simply tracks the index.

Is investing in an index tracker a good idea? The short answer is — for many people — yes. Legendary US investor Warren Buffett explains why: “Most investors … have not made the study of business prospects a priority in their lives. If wise, they will conclude that they do not know enough about specific businesses to predict their future earning power.” But, as Buffett adds, by making regular investments in an index tracker, “the know-nothing investor can actually out-perform most investment professionals. Paradoxically, when ‘dumb’ money acknowledges its limitations, it ceases to be dumb.”

So, if you don’t have the time or inclination to study individual businesses as a priority in your life, an index tracker is a great idea.

A concentrated portfolio

At the opposite extreme, while having all your wealth in a single stock isn’t a good idea for anyone, some of the world’s most successful investors have argued for owning a very concentrated portfolio.

Buffett again: “If you are a know-something investor, able to understand business economics and to find five to ten sensibly-priced companies that possess important long-term competitive advantages, conventional diversification makes no sense for you … I cannot understand why an investor of that sort elects to put money into a business that is his 20th favourite rather than simply adding that money to his top choices …”

Now, I would suggest that most investors would find holding five to ten stocks simply too unnerving. Certainly, I couldn’t sleep easy with such a concentrated portfolio. And indeed, Buffett himself, in practice, comes closer to his mentor Ben Graham’s recommendation of 10 to 30 stocks.

A middle road

If you hope to earn a significantly higher return than you might get from a humble index tracker, you have to own a relatively small number of companies. But the fewer you own, the more serious will be the adverse impact if your judgement proves awry on even one or two.

Equally, the more you own, the less you’ll know about each business, simply due to restraints of time. Unless your whole waking life is spent studying companies, I’d say that by the time you get over about 30 you’re into the realm of not being able to keep up with the progress of each business in the depth needed. Over about 50 and you’re into the realm of ‘diworsification‘ and reducing your chances of earning a significantly higher return than a no-effort index tracker.

In summary, there’s no ideal number of stocks to own. An index tracker will be the best choice for many people, while for investors in individual stocks, available time and tolerance of risk are important considerations in sizing your portfolio.

The post How many stocks should you have in your portfolio? appeared first on The Motley Fool UK.

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• £15,000 invested in UK shares a decade ago is now worth…
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• Prediction: Diageo shares could soar in the next 5 years if this happens…
• With a P/E of 5.9 is this a once-in-a-decade opportunity to buy dirt-cheap easyJet shares?

G A Chester has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

First, let’s think about the fundamentals. What determines whether a stock will rise or not? In one word, profitability. You need to invest in businesses that are likely to make strong earnings now and for years to come. You also want long-term investments that will trend steadily higher. Are these stocks that you can buy and forget about?

Go where the profits are

You need to consider where in the world the growth will be. Although you may know less about other regions, you need to be brave and look beyond the shores of the UK. And, wherever possible, think contrarian: when you genuinely believe in the prospects for a company, buy when others are selling.

Let’s look at the world today. The fastest growing economies in the world are emerging market economies. The two emerging engines of the world economy are China and India. The low salaries paid in these countries, combined with a highly skilled workforce, will produce a whole new range of global titans that will rake in the profits. Investing in these giants will be a key part of your portfolio.

There’s now a broad range of emerging markets funds, and I favour investment trusts in particular. Unlike unit trusts, investment trusts are listed on the UK stock market, and so can be traded like a common-or-garden share. Most emerging market investment trusts are now trading at a substantial discount, meaning you can buy them for less than their net asset value (NAV). This can add to your returns.

These are the picks

So, pick number one: Fidelity China Special Situations (LSE: FCSS). This is the leading China fund, and trading at a whopping 15.77% discount to NAV. The original Fidelity Special Situations was run by renowned fund manager Anthony Bolton and achieved an annual return of 19.5% over 28 years. Could Fidelity China achieve something similar? It just might.

Then, pick number two: JP Morgan Indian Investment Trust (LSE: JII). There are fewer options for investing in India, but this is the leading investment trust. And with a discount to NAV of 12.9%, again this is unduly cheap, and thus a strong buy.

Then, pick three: I would choose a few carefully selected UK companies with a large stake in the future. One clear trend is a boom in global consumerism. Another is growth in emerging market financial services. And another is the rising demand for healthcare services. Next is a global retailer that looks cheap at the moment. My contrarian instincts draw me to banks with a substantial business in emerging markets, such as BGEO and HSBC. And AstraZeneca is one of the world’s leading pharmaceutical companies. Pick a handful of these businesses for your portfolio.

Invest one third of your money in China, one third in India, and one third in these well-chosen British firms. Sprinkle well with cash, and wait, very patiently, for the bull market to get underway. In a few years, your investments should be blooming.

The post What makes the perfect portfolio? appeared first on The Motley Fool UK.

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Prabhat Sakya owns shares in Fidelity China Special Situations and JP Morgan Indian Investment Trust. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

We can mitigate the risk by not putting all our eggs in one basket and instead, by keeping a diversified portfolio. If a company that crashes accounts for 50% of your stock market investments, you’ll suffer a lot more pain than if it’s just one stock out of 10 or 15 or so.

But if you ‘diversify’ through buying shares in 10 different companies in the same sector (for example oil exploration), then you can still be in deep trouble if the sector suffers a calamity. The answer, of course, is to spread your cash across companies in different sectors.

Easy enough?

That sounds simple, but there are some easy mistakes that people regularly make, and the biggest is to over-diversify (or ‘di-worse-ify’ as some people call it). The problem is, the more you diversify the lower the incremental benefit gets. Your second share will make a big difference to your safety, but the 10th a lot less.

It’s been academically tested too. Two researchers in the 70s by the names of Edwin Elton and Martin Gruber measured what’s called the “standard deviation” of annual portfolio returns depending on the number of individual investments they held.

By the time the 10th share is added, they found there’s really not much benefit, by 20 shares even less, and by 30 shares there’s pretty much no benefit at all. In fact, by that stage you’re very unlikely to do better than an index tracker, so you might as well just get one of those instead and save on the effort.

Don’t buy junk

Another mistake comes from buying a poor share just for the sake of diversification. You might have, say, shares in 10 companies that you really like but end up buying several more in which you have less confidence just to make up the numbers. And that very much goes against the core Foolish principle of understanding what you’re investing in and only buying shares that genuinely satisfy your investment criteria.

So what’s the best number of shares to hold for diversification purposes? I’d say it depends on your approach to risk. If you don’t mind a bit of risk, then five or so shares from diverse sectors will make a significant contribution to safety. But if you’re really averse to risk, then I think around 15 stocks really is about the most you’d need.

Portfolio

But what should you buy for a diversified portfolio? That depends on your strategy, but to start I might suggest a bank like Lloyds Banking Group, an out-and-out dividend share like National Grid or SSE, an investment in oil like BP or Royal Dutch Shell,  a long-term pharmaceuticals prospect like GlaxoSmithKline or AstraZeneca, and (seeing as I don’t mind a bit of risk) a strong growth candidate like ARM Holdings.

To take it towards 10, perhaps a solid insurer like Aviva and a global household goods maker like Unilever, but then I’d be struggling on the diversification front because I prefer to choose shares on their own merits in isolation rather than on what diversity they might provide.

The post Why You Should Diversify Your Investments appeared first on The Motley Fool UK.

More reading

• Why I think the HSBC share price could hit 2,000p by December
• £15,000 invested in UK shares a decade ago is now worth…
• 3 FTSE shares with many years of consecutive dividend growth
• Prediction: Diageo shares could soar in the next 5 years if this happens…
• With a P/E of 5.9 is this a once-in-a-decade opportunity to buy dirt-cheap easyJet shares?

Alan Oscroft owns shares in Lloyds Banking Group and Aviva. The Motley Fool UK owns shares of and has recommended Unilever. The Motley Fool UK has recommended ARM Holdings, AstraZeneca, GlaxoSmithKline, and Royal Dutch Shell. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.