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Author: calhammond One star, 50 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 6725  
Subject: Re: How many is too many? Date: 12/17/2004 9:59 PM
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Hi TP2004,

You asked for two things. The first was "How many is too many?" in the subject line and then "Advice?.

I'll answer the first, first, since it has an easy answer:

Answer: IT DEPENDS.

In other words there is not a specific number for the number of stocks a person should own. You seem to be looking for a formula or rule. There are those that will tell you that such exist and they do. Some will be glad to sell them to you. Usually they have to do with the percentage of a person's portfolio that should be in bonds (equal to you age, or some variation on that theme). But I think you are looking for a good rule of thumb number. I don't think such exist.

In some cases a person should not own any stocks at all (any case where a significant increase in wealth would not increase standard of living or quality of life while a significant decrease in wealth would result in a devastating reduction in quality of life). So, the first part of "it depends" is risk tolerance and risk benefit ratio analysis. This is why as one ages the advice is to increase weighting in fixed income instruments. But even that guideline assumes that young people can recover from a major loss since they have more earning time to make it back up, which is not always true. It also asumes that older people are risk intolerant and reward insensitive, also not always true (you can't be fired from a pension and social securitie.)

On the upper side, I think that there is a maximum number of stocks that a person can reasonably follow. By reasonably follow, I don't mean checking in on it every hour, or every day or even once a month. I mean doing a quality look at it periodically (once a quarter, once a year) and set up a system to alert you to significant changes in the "the story of why you bought it". I'll get into "the story" in more detail in the answer to "ADVICE?). Again the maximum number is different for different people. Someone with $100M, a lot of time and a staff could handle a large number. But for individuals I think that 50 would be outside the normal range and, probably, most people could handle 10 to 30 stocks. Again, it depends on the time available, inclination to exert the effort, risk tolerance, etc., etc. (redundancy to show lots of cetera ;-).

Now ADVICE?

BUY A STOCK BECAUSE YOU BELIEVE THAT OWNING THAT COMPANY WILL GIVE YOU SIGNIFICANT REWARDS (SUBSTANTIAL REWARDS IF RISK IS HIGH). I put BELIEVE is bold because the belief should be after Due Diligence (DD). This means that you understand the company's story: what it makes, how it makes money, why it should continue making and paying out money (if a dividend stock) or why it should grow and become more valuable, i.e. its business model. If it is a growth stock, you should also believe that that it will grow faster than the current price reflects. I'm using believe in the sense of coming to a conclusion. Conversely, it also means you should not buy because of: hope, desire, fear of missing out on a good thing, everyone else is, rumor, insider advice (illegal), posting on a web site (although that may be a reason to study or consider), advice in the mail, email solicitation, etc.

You should also identify margins of safety. If the story changes to the negative or the margins of safety go away, then the stock should be sold. Margins of safety are no debt or a strong cash position. These don't assure success but do give the company to weather the setbacks which are bound to occurr.

Only buy as much as you can stand the risk on. Or, stated another way, only as much as you wouldn't lose sleep about if it dropped to 1/2 its initial value (I believe this is from W. Buffett, anyway it seems to be a reasonable rule of thumb). The only way I know to avoid panic is to keep positions small. Panic is you enemy. Optimism is NOT your friend. More money is lost by chasing the market than any other way. What I mean by chasing the market is buying when the market is up and selling when it goes down (different than buying when the market starts up and selling when it starts down, but not always a clear distintion).

Also, keep a good measure of humility. You can know all the fundamental facts of a company; know it inside and out. It can be a perfect company, everything can have come together. An idiot could run it and the guy running it is hardly an idiot. You see an opportunity to make it rich on this one investment. Swing for the fence. Don't! That CEO who's not an idiot could turn out to be a crook, the CFO could also be ethically challenged, a key individual in the company could leave taking the company's secrets with her, another company could come in with an improvement taking all of the business, something totally unrelated to the company's business could destroy its assets... There are no sure things.

Having fewer good stocks in your portfolio increase your return but also increase the impact of any failures. As you increase the number of stocks you own, the up side potential decreases (you could find one stock that could triple or more, but finding 10 that triple is highly improbable), but as you increase the number of stocks the probably of finding one outstanding stock goes up (as does buying a bad one). However, if you develop a good selection process, you will shift the probability in your favor and your portfolio will outperform the market. If you keep increasing the number of stock selections, the selections will start approaching random (which is to say approaches the average investor selection) and revert back to market averages. If your investment selection process is flawed or poorer than average (or simply counter to popular sentiment), then the larger portfolio will again bring you back up closer to market averages.

The third and last piece of advice has to do with time. Time can be your friend. You can invest in outstanding companies, but, if they are in a segment of the market that is out of favor, they may perform poorly for a significant period of time (a year, two years). But over the long term the market will come back to that segment. Besides, a good company that keeps growing its earnings will get noticed (there are a lot of people screening for companies with consistant earnings growth).

Back to the advice on only buying as much of a stock as you can take the risk on. The risk is not only in the company itself, but also the economy, the market, the segment of the market, government policies, your needs, and all sorts of other things.

Advice? Buy stocks that you believe in. Find recommendations from reliable sources (TomG seems to have a pretty good track record). If after DD, you would like to be a part of that company as an owner take a reasonable stake in it. Make a list of why you bought the stock and any potential concerns or reasons to get out. Keep it until the fundamentals change (a bad quarter or bad news will happen, when it does ask yourself "Did fundamentals of why I made the investment change significantly?" The discussion boards here will help you with that question.

Pay down high interest debt (credit cards), maintain some investment in fixed interest instruments (again risk balance is important).

Wellcome the the world of hues and color. A bit more complex than black and white but prettier and a bit more rewarding. ;-)Keep learning.

I hope this is helpful,

CalH.


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