I suppose that you could feel rather hurt if a friend or colleague described you as a basket case but in the world of investing, that’s what I am. So why am I a basket case? Well that's easy to explain really in that I seek the comfort of a collective of stocks within my portfolio rather than simply relying on one or two stocks; it’s all about that simple old concept of managing risk. For me, investing needs to be something I do that will hopefully make me a positive return on my capital whilst being able to sleep soundly at night. I painfully recall the days back in the late 90’s when at times I ran a very concentrated of just a handful of stocks, at times about four or five, and experienced what an underperforming stock may do to both your concentrated portfolio and indeed, your serenity.
You could well ask why don’t I become the ultimate withdrawn basket case and just invest in managed funds which after all usually have upwards of 40/50 stocks and frequently more. Well, the sad truth is that an alarmingly high percentage of fund managers dismally underperform the market. Ok, there are some star managers out there but I would say that over time you would be better off investing in a low-cost tracker than a managed fund. Why are the fund's performances generally so poor? Well, a fair part of this is down to the manager’s fear of falling below the index for that particular style of fund; not only could the fund manager’s bonus be at risk but after a couple of years of underperforming indeed his continued employment which is often determined by how he performs against his peers. All a bit of a sad situation that results in that large percentage of fund managers, despite having a fairly substantial basket of shares, failing to do even achieve the performance of a simple tracker fund. However, as private investors, we have within our grasp quite incredible control of our investment universe. Firstly we can use whatever screening, research or other technique that selects that universe from which we decide to buy a stock from. Secondly, we decide how much of our “hard earned” we want to expose to that purchase: yes, with every purchase there is an element of risk but there are ways of mitigating that risk but risk in general terms calls for a future article dedicated to the subject. The risk we expose ourselves to is in my view especially great if that stock is the only holding within our portfolio.
Well, you may ask surely with that one share we can simply sell if things don't progress as desired and the price drifts slowly down. Well, yes we can in that scenario we can sell easily and move on but with every stock, I am always mindful that a profits warning could be just around the corner. Now a profits warning can hit the really big boys as well as the tiddlers; look at retailer Next & rail/road passenger operator Stagecoach both of whom dramatically dropped before the markets opened with a 7 am RNS profits warning, you simply don't have the opportunity to react before the initial mark down of the share price on bad news. Yes, you can sell rapidly on a profits warning as I invariably do and thus avoid the next few months of gradual decline but you just can't avoid that early pre 8 am hit; don't lose sleep over it but do ruthlessly manage it.
That risk can certainly be greatly reduced by holding more than one stock i.e spreading the risk: by holding two stocks, if one suffers a profits warning and the unfortunate stock falls by 20% in value, the damage is balanced over the portfolio and the bottom line suffers by only 10%. However let's say we own five stocks, then that hit on the value of the portfolio falls to a still uncomfortable but manageable 4% assuming equal weighting of the stocks. Doing the maths, the loss following a -20% drop on a profits warning falls to 2% with ten stocks and only 1.3% with fifteen stocks.
What has this taught me over the years is that I feel comfortable and certainly more secure in being a totally committed basket case with that basket of shares in my portfolio usually comprising around thirty stocks which I don't find anything of a challenge to manage given the wonderful IT available at the click of a switch; no idea how I managed back in the 90’s but to be fair I rarely exceeded eight or ten stocks in those days and at times as little as four or five; I remember the uneasy sleep pattern only too well.
Now being a basket case has other advantages of course as well as impact of profits warning mitigation:
Is it more expensive being a basket case? Well possibly it is marginally more expensive in terms of dealing charges but you can minimise that cost by using a £5 or so per transaction broker. The tax charge in terms of stamp duty is the same; here I am leaving to one side the differences between duty on the main market and AIM.
As you know, I don’t offer advice, I merely whitter on about my thoughts but if my relative Matt Tress, he was the subject of an earlier blog, were to ask me my opinion of the minimum number of shares he should accumulate, then I would say about 15 shares.
Why do I say 15 stocks? Well, The simple fact is that even the very best investors we read about simply don't get it right every time in terms of every share purchase becoming a winner. In fact, I was listening to a podcast recently when one of the very most universally respected investors said that around 6 out of 10 of his picks are not successes: as ever, it's the way you manage your portfolio that is crucial; ruthlessly jettisoning the stocks that the market does not smile upon. So if we have a basket of stocks rather than just the odd one or two, we can continually improve the performance of that basket by managing those under performers whilst building possibly larger positions for the appreciating stocks.
I use this culture constantly in my own portfolio ruthlessly without sentiment or regret, weeding out any underperformer before it can have a material effect on the portfolio. The strange thing is the way we are emotionally wired and the sense of relief one feels having had the courage to exit a losing position.
So in summary, my reasoning for being a committed basket case is:
Welcome to my Blog Page - I hope you find my whittling on to be of some interest. I am a private investor who is happy to share thoughts on the market and individual stocks. Please remember that I am definitely not offering tips or investment advice.