The newest investment fad is called “CONCENTRATED INVESTING” and there is even a new book that just came out on the subject. The idea is to pick a tiny handful of the best stocks, the few that are going to go up one-zillion-percent in one month, and to shun the rest. Intuitively, most people would understand that this would be a dangerous proposition that is fraught with difficulty, however the idea is rapidly gaining in popularity as people re-forget that the tortoise beats the hare and with much less effort.
Concentrated investing is the exact opposite of holding a much lower-risk diversified portfolio. According to J.P. Morgan, since 1980 (in the Russell 3000):
- Almost half of all stocks have suffered a PERMANENT loss of more than 70%.
- The return on the average stock has been a 54% loss.
- 66% of all stocks have had a negative absolute return.
- The number of historically outperforming stocks is only 7% and this leaves a 93% chance of picking an average or underperforming or collapsing stock.
- Numerous studies show that full-time professional stock analysts are correct only 6% of the time and this fact doesn’t leave the rest of us much hope of success with concentrated investing.
The stock market can be broken down into 10 different sector classifications and each stock will naturally fall into one of these sectors. The percentage of stocks (per sector) that have experienced “catastrophic loss” of greater than 70% since 1980 are shown below (chart courtesy of J.P. Morgan):
Concentrated portfolios – MarketCycle’s thoughts:
- If you own a stock it simply means that you are part owner in the company that issued the stock.
- Stock ownership can be the low risk pathway to great wealth.
- A larger diversified portfolio of stocks has substantially less risk than holding just a few companies.
- With stocks, sector selection (based on which part of the market cycle we are in) is more important (and more profitable on a risk adjusted basis) than is individual stock selection.
- A “sector,” such as the “technology sector,” could hold a hundred different viable tech stocks, providing important diversification and “safety in numbers.”
- In our opinion investors should be concentrated into carefully selected stock SECTORS (based on the market cycle) and not individual stocks. ETFs are perfectly designed for this purpose.
- It is impossible to consistently know in advance which individual stocks will outperform… it is only hindsight that is 20/20.
- Regression to the mean causes individual high-flying stocks to eventually fall and it also causes weak, unpopular stocks to rise. This is one important reason why a larger grouping of stocks, over the intermediate and longer-term, will likely beat a portfolio that only holds a handful of stocks.
- A stock index such as the S&P-500 will exhibit prolonged and profitable directional trending behavior while an individual stock is ultimately random in its price moves. Stock sectors, just like a stock index, will also trend.
- The odds of consistently picking the few top performing stocks is very close to 0%; investors easily delude themselves into believing that they are better at this activity than they actually are…
- With stock picking, even investment professionals and stock analysts are not as good at hitting the target as they may believe…