Diversification – sometimes affectionately called diworsification – is in my view essential.
You need only look at the model portfolios from 2013 that were not sufficiently diversified to see why.
Diversification saves us from ourselves, our emotions, fear and greed and the biases we bring to the market.
If you want to make sure that you do not lose your shirt, then diversify you must.
Why Graham And Dodd Recommends That You Buy Unloved Stocks
I like to buy cigar butts and I’ve bought a number of them recently.
I also like to buy fear, in other words, a stock may not be selling at a 50% discount to book value but if it is hated by the market I’m likely to be a buyer if the market’s reaction is extreme, which it often is.
They are the ugly unloved companies that people would most likely never of heard of.
I’ve got a ‘thing’ for garbage.
Is a company is going through some sort of temporary unpopularity?
It’s not because I’m some sort of stock market narcissist dancing around a camp fire at night in my boxers praying for doom.
It’s just that Graham and Dodd‘s deep value way of investing is the least stressful and most profitable that I’ve personally tested over the years.
Well researched studies by boffins far brighter than me come to the same conclusion.
The trouble with this type of value investing is that is counterintuitive to the mainstream idea of how to invest in stocks.
But even more troublesome is that with the type of stocks that are hated by the market there is normally just no way of telling what will happen to the stock price in the near term.
Sometimes after entering a new position stock prices can go nowhere for months/years at a time.
Other times stocks will continue their downward spiral and destroy your capital.
This is one of the many reasons why diversification is essential because if you have enough stocks in your portfolio, studies have shown that you significantly reduce the risk you are carrying at any one time.
By way of example it’s no good holding onto a bunch of car manufacturers if that’s all you hold in your portfolio.
What happens when car manufactures are being smashed by the market due to some negative news? What if the economy weakens and people and firms cut back their spending on cars?
You have to diversify.
How To Easily Ensure Your portfolio Is Sufficiently Diversified
You have to ensure that your stocks are representative of a wide range of different sectors and industries to ensure that your entire portfolio does not get dragged down due to bad news from one industry or sector.
How many stocks should you have in your portfolio and how diversified should they be?
Subjective as these questions are I can only tell you what I try to aim for:
- A portfolio of between 15 – 25 stocks
- A Maximum of two stocks from the same sector but mostly just from one
Terry Smith from Fundsmith has espoused this simple diversification technique for years and combines this with a low portfolio turnover for excellent results.
If you follow a similar portfolio strategy then you’ll be reducing your risk and sleeping at night (or dancing around in your boxers) will be a breeze. The ‘diworsifiers’ need to get a life.
- 10 Things I learned From The UK Investor Show – Part 2
- Why Graham And Dodd Is Still Relevant Today
- How To Protect Yourself From Stock Market Losses
- FREE! Value Investing Ebook