Diversification

[Degen]

My strategy up to this point has been to put all of my investment money in one or two investments that I think are excellent. Whether this be a hot stock or a piece of real estate or a business or whatever. I've been taking my whole pile and shoving it behind ventures I see as outstanding.

I'm 25 and a professional poker player...I embrace calculated risk taking.


This article (http://finance.yahoo.com/columnist/article/richricher/1649) reinforces my position:

Recently in the Portfolio thread somebody suggested this was poor.


Anybody care to weigh in on either side of this?

Younger people can gamble more with their money (i.e not hold bonds, T-bills).
Your capital allocation is most important, that is, where you put your money.
Putting all your money in 1 venture is not very smart.
Put 20% in bonds, the rest in 5-10 stocks and experience the magic of compounding.

[Warren Whitmore]

I like your style. Another quote from Warren Buffett from "Buffett & Gates on success." "When you see something exceptional that is not the time to read a book called the fundementals of the efficient market theorem. It is the time to take the thumb out of your mouth."

[Degen]

[ QUOTE ]
Put 20% in bonds, the rest in 5-10 stocks and experience the magic of compounding.

[/ QUOTE ]

Also known as 'diversification'

Other than you saying that my strategy 'isn't smart' do you have any other thoughts to add on why?

[ QUOTE ]
[ QUOTE ]
Put 20% in bonds, the rest in 5-10 stocks and experience the magic of compounding.

[/ QUOTE ]

Also known as 'diversification'

Other than you saying that my strategy 'isn't smart' do you have any other thoughts to add on why?

[/ QUOTE ]


Sorry mate, I was referring to that you don´t have to diversify
in the sense of investing in 20+ stocks,mutual funds,bonds,t-bills, or index funds.

But it would still not be smart to invest in just 1 venture. There is no such thing as a sure thing, you are simply not getting the return that justifies the risk.

Are you implying that if you invest in more than 1 venture, say two stocks, than that is 'diversification' ?
Surely not.

In the end it all comes down to how much money you have.
If it is $1000, then go ahead and throw it at 1
stock/venture.

If you however have say $100,000-$1,000,000 Than you have to be more passive.

That´s just my opinion

If a perfect system existed, everyone would use it and the market would cease to fluctuate.

The upside of your system is that if you're right, you'll clean up; the downside, you might wake-up one morning and find that much of your net worth has disappeared.

[DesertCat]

[ QUOTE ]
My strategy up to this point has been to put all of my investment money in one or two investments that I think are excellent. Whether this be a hot stock or a piece of real estate or a business or whatever. I've been taking my whole pile and shoving it behind ventures I see as outstanding.

I'm 25 and a professional poker player...I embrace calculated risk taking.


This article (http://finance.yahoo.com/columnist/article/richricher/1649) reinforces my position:

Recently in the Portfolio thread somebody suggested this was poor.


Anybody care to weigh in on either side of this?

[/ QUOTE ]

Well, you are a pro poker player. Do you embrace playing for your entire bankroll at a single game, no matter how fishy you think it is? Why would you manage your portfolio less expertly than you handle your bankroll?

Actually I don't totally disagree with the approach, I in fact have a goal to get my portfolio down to 5 stocks. It never happens, due to the vagaries of relative prices to value ratios of what I'm holding and what I can buy. But I'm around ten stocks now, and have three stocks that are over 50% of my portfolio.

But I spend all day every day researching stocks. Expecially reresearching my existing holdings. I don't own any "hot stocks". Everything I own is cheap in relation to it's true value, so I limit my downside risk carefully. My "bankroll management" strategy ensures that worst case, if I totally whiff on my research and have a position go to zero, I can't lose more than 20-25% of my portfolio.

In reality, most stocks have almost zero chance of total loss, so I'm typically taking the risk of a 10-15% loss from a single position dropping by half or more before I discover my mistake. One exception is that I occasionally take some positions where the risk of the stock going to zero is much higher than normal (but have much higher than normal upside if they don't). I will never put more than 10% into one of those positions, not matter how good the upside.

One of your previous posts stated you were 100% GOOG. I think this is tremendously unwise. It's not just a question of GOOG being a good co., it's a question of whether the market is overvaluing it or not. You have all sorts of risk, from competition, to valuation, to market size and growth.

Another post indicates you use stop losses to protect yourself. This is okay, but stop losses are also a way of missing out on big gains, just because they were proceeded by a small dip. The reason to own a stock is that you believe in it's upside and it's current valuation. Selling it when it's cheaper and more attractive isn't a route to riches.

As far as private businesses go, I have a friend who's made millions from starting software companies. He is a certifiable business genius. He put it all in his latest venture. He is now flat broke and near bankruptcy. Twenty years of hard work is now gone, he's starting over. That may not scare you at 25, but it sure will at 40.

In summation, I only recommend focused portfolios if you really understand how to research and value investments. Even then, you have to follow a porfolio strategy to control risk. Otherwise take the passive approach and get an index fund.

[Ed Miller]

[ QUOTE ]
One of your previous posts stated you were 100% GOOG. I think this is tremendously unwise. It's not just a question of GOOG being a good co., it's a question of whether the market is overvaluing it or not. You have all sorts of risk, from competition, to valuation, to market size and growth.

[/ QUOTE ]

While DesertCat's entire post was excellent, I wanted to requote this. The idea of concentrating your portfolio into a few superstar investments is one that has its place... IF YOU ARE VERY KNOWLEDGIBLE.

With all due respect, I believe your judgement isn't developed enough yet to make concentration work for you. Mine certainly isn't either. There are intelligent people like DesertCat who spend 40 hours a week, every week, researching, reevaluating, making mistakes and learning from them. I don't think you've done that... and until you do, there are levels of knowledge you haven't yet attained.

I don't know your story, but I have the feeling that you are long on smarts, but a little short on experience. I think if you continue to invest your portfolio heavily in stocks like GOOG, you will get horribly burned one of these days.

[Uglyowl]

Out of a field of 7,500 actively traded stocks you should be able to come up with 5-10 that are good values.

There are so many wild cards out there that make not diversifying to a certain extent foolish.

[AceHigh]

[ QUOTE ]

Anybody care to weigh in on either side of this?

[/ QUOTE ]

It's risky, I like to have around 5-10 stocks. But I'm sure you can be successful doing it.

If you are going to take this strategy I think you have to get out of your losers fast. Really fast, maybe stop loss at 4% or so. That might be too fast. Especially because I often end up with smaller, more volatile stocks.

[DesertCat]

I went hiking today and spent a lot of time thinking about this and how much risk you want to take when you are young (i.e. 25) and older, as well as how much you wnat to take with a large portfolio vs. a small one. There are actually some interesting implications to this conundrum. I need to do some calculations but hopefully I'll post something worth discussing later...

[Sniper]

When you are young, you can afford to take larger risks, if in exchange you are getting the opportunity for larger returns... and you have a consistant stream of income.

If you are young and your port is small, again you can take larger risks, because theoretically, the value can be easily replaced.

Diversification, can be as simple as 5 seperate stocks. The main point of diversification is that no single event should be able to wipe you out. As I think Ed pointed out, you wouldn't take your whole poker bankroll and sit down with it at a NL table (that would be an unacceptably large risk), or place it all on black /images/graemlins/smile.gif

As you get older and your port gets larger, you can still take some wild risks, but you should only do so with a portion of your portfolio. Some of the experts recommend that you take 10% of your port and use it to make riskier "bets" than your normal risk tolerance for the remainder of your port. If you are successful, the extra risk can have a substantial impact on your total return, while if you are wrong, the total impact of the risk is relatively small.

[DesertCat]

I was thinking about whether it's worthwhile for younger investors to take more risk for a higher reward. I posed the question, what if you could invest 100% of your portfolio in one of two investments each year. Investment One is the "high risk" investment, 45% of the time it was worth zero at the end of the year, but 55% of time it would double at the end of the year.

Your other option is the "no risk" investment. 100% of the time it's worth 10% more at the end of the year. You are 25 years old and saving 50k per year, and want to retire wealthy, which you believe will require $5M.

On the surface, the EV of both should be the same, +10% per year. But the high risk option offers much more upside, at the risk of having to start over every so often. Let's also assume you are 25 years old when you start.

If you only choose the no risk option, I estimate you'll have $5M about age 50. The high risk option can get you there in a little over 6 years (age 31). But only does this once in thirty six times. Presuming you switch to the conservative approach after busting, 97% of the time you'll have to work an extra one to six years until retirement.

I looked at taking shorter periods of risk, then switching to the no risk investment. For example, if you only tried the high risk option for three years, one sixth of the time you'd make $550k by the third year and retire by age 46.5. But the rest of the time you'll be working an extra two or three years. Two years of high risk only allows you to retire at age 48 a little less than one third of the time, while adding two more years of work the majority of the time.

These are all assuming I did the math right. And I don't pretend to say my super simplified scenario closely approximates the index funds vs. putting it all into one investment risks/rewards.

But I just couldn't find a scenario where I felt that taking the risk was clearly the better option. And I think it's because of one important factor, the relative utility of having more money. Having $2M doesn't normally make you twice as happy as having $1M. The relative utility of every increasing dollar you accumulate is less than the previous.

In fact, just having a significant amount of cash in the bank has tremendous value. It provides you with more opportunities. More investment opportunities (i.e. buying a business for example). It gives you more freedom, the ability to work at jobs you like over jobs you need, for example. Going back to zero has significant opportunities costs. You'd hate for it to happen just before finding the one great investment opportunity of your life. Having money provides so many options it would be miserable to go back to ground zero after you've accumulated a reasonable amount.

Or maybe I'm just getting cranky and conservative in my old age:)

[AceHigh]

[ QUOTE ]
On the surface, the EV of both should be the same, +10% per year.

[/ QUOTE ]

But shouldn't we assume there will be a payoff for taking the risk, and so the higher return/EV? The lower risk option should be more attractive if the EV's are the same.

[DesertCat]

[ QUOTE ]
[ QUOTE ]
On the surface, the EV of both should be the same, +10% per year.

[/ QUOTE ]

But shouldn't we assume there will be a payoff for taking the risk, and so the higher return/EV? The lower risk option should be more attractive if the EV's are the same.

[/ QUOTE ]

Now you are talking Efficient Market Mantra (greater volatility being associated with higher returns), which I don't believe in. Turn it around, if you could invested your one thousandth of your portfolio at a time in these opportunities. You'd end up with similar returns no matter whether you put your portfolio in one thousand "no risk" opportunities vs. one thousand "high risk" opportunities. Essentially over many iterations, they are offering the same "risk adjusted" return.

[AceHigh]

[ QUOTE ]
[ QUOTE ]
[ QUOTE ]
On the surface, the EV of both should be the same, +10% per year.

[/ QUOTE ]

But shouldn't we assume there will be a payoff for taking the risk, and so the higher return/EV? The lower risk option should be more attractive if the EV's are the same.

[/ QUOTE ]

Now you are talking Efficient Market Mantra (greater volatility being associated with higher returns), which I don't believe in. Turn it around, if you could invested your one thousandth of your portfolio at a time in these opportunities. You'd end up with similar returns no matter whether you put your portfolio in one thousand "no risk" opportunities vs. one thousand "high risk" opportunities. Essentially over many iterations, they are offering the same "risk adjusted" return.

[/ QUOTE ]

Well, think of it this way, if we are only buying one stock from our list of top stocks, our lock of the year or whatever we want to call it, shouldn't it outperform our own picks of top 10 or top 25 stocks?

We don't expect all of our picks to perform equally do we?

[Degen]

[ QUOTE ]
[ QUOTE ]
[ QUOTE ]
Put 20% in bonds, the rest in 5-10 stocks and experience the magic of compounding.

[/ QUOTE ]

Also known as 'diversification'

Other than you saying that my strategy 'isn't smart' do you have any other thoughts to add on why?

[/ QUOTE ]

is no such thing as a sure thing, you are simply not getting the return that justifies the risk.


[/ QUOTE ]

I had it all in GOOG for several months and more than doubled up (with margin). What was my risk there? Not much with my stop-loss usage...

In the case of a business...there may be a lot more risk than with a stock, same with real estate...but there is very little risk of ruin (or even profit ruin) if I do it smart...IMO.

This is all assuming smart investments...a big assumption.


[ QUOTE ]
Are you implying that if you invest in more than 1 venture, say two stocks, than that is 'diversification' ?
Surely not.

[/ QUOTE ]

No. Just that another great investment might present itself before I have decided to exit the first.

[Degen]

[ QUOTE ]
[ QUOTE ]
My strategy up to this point has been to put all of my investment money in one or two investments that I think are excellent. Whether this be a hot stock or a piece of real estate or a business or whatever. I've been taking my whole pile and shoving it behind ventures I see as outstanding.

I'm 25 and a professional poker player...I embrace calculated risk taking.


This article (http://finance.yahoo.com/columnist/article/richricher/1649) reinforces my position:

Recently in the Portfolio thread somebody suggested this was poor.


Anybody care to weigh in on either side of this?

[/ QUOTE ]

Well, you are a pro poker player. Do you embrace playing for your entire bankroll at a single game, no matter how fishy you think it is? Why would you manage your portfolio less expertly than you handle your bankroll?

[/ QUOTE ]

The risk of going bust at a NL table is a bit different than in an investment. It happens probably over 10% of the time with the poker example...

Great responses all around, nice little forum we got here...

Now to find me next wonderkid...(maybe with 25% of my fund this time /images/graemlins/grin.gif )

[lastsamurai]

Let me ask you a few questions...
1. How much are you investing?
2. Are you investing in stocks?

William Oneil saids even if you have 100K in the market dont over diversify your portfolio...Find 4-5 good investments to buy and cut your loses. General rule is 8%. With the extra cash you could build more posistions in your other winners... Go buy "how to make money in stocks" and read the section on when to sell. It's one of the best books to read out there.

[Degen]

[ QUOTE ]
William Oneil

[/ QUOTE ]

How do you think I found Goog? It's been atop or near the top of the IBD hot picks for so long...

$ amounts I don't find relevant to this discussion...I invest in anything I think can make money /images/graemlins/smile.gif Right now I'm going head first into a business venture that I am now rethinking my personal financial commitment to...don't wanna become an example in a thread like this a couple years from now...

[DesertCat]

[ QUOTE ]

Well, think of it this way, if we are only buying one stock from our list of top stocks, our lock of the year or whatever we want to call it, shouldn't it outperform our own picks of top 10 or top 25 stocks?

We don't expect all of our picks to perform equally do we?

[/ QUOTE ]

No, of course not. But our pick of the year doesn't always outperform, sometimes we make mistakes. That's why my goal is five stocks, it's enough diversification to prevent one bad pick from killing me, without forcing me to buy a bunch of lower quality opportunities just for diversifications sake.

My memory tells me (for however accurate that is) that the returns from my #1 picks haven't been much higher than from my #2-#5 picks over time. In fact I can remember several that I thought were the greatest ideas ever that turned out to be lousy.

This thread is motivating me to prune some of the worst ideas out of my portfolio now. I have ten positions and some of them are "mistake refusals", stuff I bought that turned out to be mistakes, and I'm waiting for slightly better prices to unload so I can make a small profit and declare victory. This is very bad behavior (see the behaviorial investing thread) and I'm going to heal myself right now.

[AceHigh]

[ QUOTE ]
My memory tells me (for however accurate that is) that the returns from my #1 picks haven't been much higher than from my #2-#5 picks over time. In fact I can remember several that I thought were the greatest ideas ever that turned out to be lousy.

[/ QUOTE ]

I think sometimes we are going to have 5 good picks and sometimes we are going to have 2 good picks. We should take all 5 when we have 5 good picks, but I'd rather go 100% on 1 good pick if that's all I have, than to pick 4 other mediocre stocks to just to fill out my portfolio.

Do you rank your picks? I have stocks I like more than others I buy, but I don't really rank them.

[ QUOTE ]

This thread is motivating me to prune some of the worst ideas out of my portfolio now. I have ten positions and some of them are "mistake refusals", stuff I bought that turned out to be mistakes, and I'm waiting for slightly better prices to unload so I can make a small profit and declare victory. This is very bad behavior (see the behaviorial investing thread) and I'm going to heal myself right now.

[/ QUOTE ]

"Selling doesn't create a loss, it stops the loss from growing."

Leon Allen

[DesertCat]

[ QUOTE ]

Do you rank your picks? I have stocks I like more than others I buy, but I don't really rank them.

[/ QUOTE ]

I do rank my ideas, by discount to estimated intrinsic value, and estimated return over a reasonable holding period. It's sometimes difficult to compare a good long term hold vs. a merger arb, since the holding periods are so different. But I almost always prefer the great long term investment to a great short term investment, not just because of the benefits of tax free compounding over years, and lower long term capital gains rates, but because it's also less work.

If I could find five great long term holds, I'd have little to do other than play poker all day...

[buffett]

[ QUOTE ]
If I could find five great long term holds, I'd have little to do

[/ QUOTE ]
I always wonder what Glenn Greenberg (http://www.sec.gov/Archives/edgar/data/789920/000095012305013583/y14658e13fvhr.txt) does all day.

[DesertCat]

In thinking more about this thread I'm wondering if my advice was way too risk adverse for Degen.

I quit college before finishing to work at a software startup that was near bankruptcy for the first year. Fiver years later I quit the best paying job I ever had to co-found a software company with a friend. In the first case I didn't get rich, at least financially, but what I learned was priceless. In the second case we (after many years of wonderfully hard work) sold the company for enough to allow me to become a full time investor.

So I'm a big believer that the one of the best routes to riches (or at least comfortable laziness in my case) is starting a business. That's taking risk. Though I had little to risk in both cases. In the first I was broke. In the second, I knew I could get a good job if we failed, and was only investing sweat equity.

If you want to put a couple years of savings into a business you truly believe in, go for it. Do your research of course. And if it fails, you are only two years behind and probably learned something valuable.

But if you've built a big nest egg, that's a guarantee of a signficant and growing income stream for the rest of your life. If you protect it. Start a business if you want, but try not to put your entire life savings in it. Scrimp and get by until the business starts generating income.

My friend's failure is that he always viewed business as a roulette wheel, you take big risks for big rewards. That's great when you have little to lose. But once he got rich, he still wanted to be richer, and was too impatient to change his ways. He ended up putting it all down on red, and spun that wheel one time too many.

[lastsamurai]

At this point i would just ride your winner...make sure you use your stops...The last thing you want to do is to let your potential 10 bagger go....

[Peter666]

This strategy is correct for getting the greatest gains. Risk has MUCH more to do with knowledge than diversification.

Basically, get a handful of companies you like, get to know them extremely well, then buy them up when you see value. That's how to make big $. I did it with NFLX this year, and I am doing it with ADBL now and in the coming year. Stick to your convictions.

My other rule of thumb: if you can't reasonably beat Berkshire Hathaway's average performance within one year (20%) you should not have your money anywhere else but in BRK. If people are spending their working lives analyzing the markets to get below BRK gains, than it is a waste of a life.

[Peter666]

"the downside, you might wake-up one morning and find that much of your net worth has disappeared."

The likelihood of this happening with certain individual stocks are almost nil. You have a much greater chance getting hit by a bus on the way to the bank.

[edtost]

[ QUOTE ]
This strategy is correct for getting the greatest gains. Risk has MUCH more to do with knowledge than diversification.

Basically, get a handful of companies you like, get to know them extremely well, then buy them up when you see value. That's how to make big $. I did it with NFLX this year, and I am doing it with ADBL now and in the coming year. Stick to your convictions.

My other rule of thumb: if you can't reasonably beat Berkshire Hathaway's average performance within one year (20%) you should not have your money anywhere else but in BRK. If people are spending their working lives analyzing the markets to get below BRK gains, than it is a waste of a life.

[/ QUOTE ]

glad to see we have forum members with real risk-management systems in place.....

[Peter666]

If people do not see value stock investing for the low risk system that it inherently is, they should keep their money under a mattress.

[edtost]

[ QUOTE ]
If people do not see value stock investing for the low risk system that it inherently is, they should keep their money under a mattress.

[/ QUOTE ]

this statement is both (mostly) true and completely different from what your previous post implied.

[Peter666]

How? Why should one own many value stocks except for a few prime ones? The more stocks you own, the less of a chance the prime ones will be able to perform for you.

[edtost]

...and the less stocks you own, the higher the chance one of them completely screws you over. bad things happen to good companies, and markets can be irrational longer than you can stay liquid.