Everything should be as simple as it can be, but not simpler..
When we look at the world of investing, one feels puzzled at the many paradoxes and contradictions one has to face while taking any investment decision. Let's take a look at some of these contradictions and how should one think about the same.
Arrogance v/s Humility
Taking a investment decision makes one naturally biased towards the outcome of the investment. This conviction (whether right/wrong) breeds arrogance and may lead to multiple behavioral biases which can eventually lead to self destruction.
A most common example of such a bias is following the latest trend - or FOMO investing (Fear of missing out) . Easy access to trading coupled with deluge of market information make it easy for gullible investors to fall prey to the market mania.
Retail investors have lapped up the recent volatility in the markets -for example Robinhood (a popular discount broking platform in USA) added nearly 3 Million new customers in 2020 with nearly half of them first time investors. In India, a similar players - including Zerodha has reported 30% -40% increase in new account additions this year.
One recent example - in US, Hertz's stock price galloped nearly 900% driven by the frenzy of amateur investors despite filing for bankruptcy. Closer home, there has been an equal frenzy in penny stocks which is bound to end badly for such investors.
While a dash of arrogance is warranted , it should be within one's circle of competence and closely monitored.
An investor should act as though he had a lifetime decision card with just twenty punches on it
This punch card mentality also enables an investor to make big bets when one is convinced about the idea. We have seen multiple examples of this earlier - Benjamin Graham's partnership breaking their own rule and investing 25% of their managed assets into one stock (GEICO) , Warren Buffett's 2016's investment in Apple- which is now 40% of total Berkshire's equity portflio!
However, one needs to be humble enough to accept one's mistake and quickly change one's decision in face of revised information.
Short term pain v/s Long term gain
One cannot expect to invest in any stock and immediately make money , as one needs to be patient and allow the business to grow its value at its own pace.
Time and again, we have seen how having a long term view and actually forgetting about quality investments can lead to immense fortune decades later. Take the example of Sylvia Bloom, a 96 year old frugal legal secretary who donated 8.2 Million dollars just from the savings from her meagre salary. How did she do it? What was her big secret?
As a secretary, she used to know about her boss's investments , and whenever the boss bought something, she would purchase the same stock, albeit in a smaller amount due to her secretary salary. Time, when added to the right ingredient, makes for some stupendous results - like the Grand Canyon.
There is also a popular investing concept called Coffee Can investing, coined by Robert Kirby, who advised buying good quality companies and forgetting them for a long period of time - allowing the winners to compound effectively.
So once you decide to invest for the Long term , allow your winners to grow big and give you the rewards you seek.
Selling your winners and holding your losers is like cutting the flowers and watering the weeds.
Volatility v/s Risk
We have been led to believe that volatility of the stock market is extremely risky. However, time and again, value investors have used such market volatility to their advantage, adding up their favorite stocks when Mr Market thinks otherwise.
Real risk of an investment is permanent loss of the invested capital due to structural changes in the investment or industry which can impair the future profitability of the business. This same thought has been echoed by our dear Warren Buffett too-
We regard using [a stock's] volatility as a measure of risk is nuts. Risk to us is 1) the risk of permanent loss of capital, or 2) the risk of inadequate return. Some great businesses have very volatile returns - for example, See's usually loses money in two quarters of each year - and some terrible businesses can have steady results.
Berkshire Annual Meeting ,2001
In fact, for the amateur value investor, these volatile opportunities come in handy for them to add more of their favorite stocks. So next time, if the market is choppy, sit back and think - does it change my investment thesis? Is there any change to the long term structural story ?
In stocks, it’s the only place where when things go on sale, people get unhappy. If I like a business, then it makes sense to buy more at 20 than at 30. If McDonalds reduces the price of hamburgers, I think it’s great.
There is a great article by John Huber of Saber Capital, where he depicts nearly 50% difference between the 52 week high/low price of the large cap stocks in the USA (which are supposed to be more 'fairly' priced due to the abundance of market information, analysts following the companies etc), highlighting the fact that even the biggest companies get mispriced periodically.
Diversification v/s Concentration
This is probably the most difficult choice which needs to be taken based on one's own temperament and appetite for risk.
If you know the edge of your circle of competence and can stomach the occasional volatility, then having a concentrated portfolio is good for you.
Diversification is protection against ignorance. It makes little sense if you know what you are doing.
However, if you are not sure of what you are doing or depending on borrowed conviction, then its safer for you to explore index funds / seek help of financial advisors.
Charlie and I operated mostly with 5 positions. If I were running 50, 100, 200 million, I would have 80% in 5 positions, with 25% for the largest. In 1964 I found a position I was willing to go heavier into, up to 40%. I told investors they could pull their money out. None did. The position was American Express after the Salad Oil Scandal. In 1951 I put the bulk of my net worth into GEICO. Later in 1998, LTCM was in trouble. With the spread between the on-the-run versus off-the-run 30 year Treasury bonds, I would have been willing to put 75% of my portfolio into it. There were various times I would have gone up to 75%, even in the past few years. If it’s your game and you really know your business, you can load up.
Hope this post was useful in nudging you towards the right path on your investment journey.
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