The Ideal Number of Stocks to Invest in
Determine the investment return you need to earn to grow the funds you have to start with to the future cost of your goals.
Question: I have heard about many investment gurus’ various ideas on the number of stocks to invest in. Some say just follow the index. Others say having a few is better because that would allow for larger gains in your total investment. Some advice to do copycat or coat-tail investing, which is really just mimicking the investment strategies of famous investors like Warren Buffett. Yet others say the strategy would depend on the prevailing condition of the market like on whether it’s bullish or bearish. What are your thoughts on the matter?
Answer: “Don’t change horses in midstream” is a proverb usually credited to Abraham Lincoln, who used it during the American Civil War to urge voters to reelect him. The proverb means you should not alter your course of action, plan or leader in the middle of a project. Put a pin on that first.
In John F. Kennedy’s inaugural address, he introduced the world to the phrase “ask not what your country can do for you—ask what you can do for your country.” Put a pin on that as well.
Here is another quote. Matsuo Basho, a Japanese poet, once said, “Do not seek to follow in the footsteps of the men of old; seek what they sought.”
Finally, Dan Benson, a financial planner who wrote the book “21 Days to Financial Freedom” says that “if you aim at nothing, you are bound to hit it.”
Now, let us put all of these quotes together to answer your question.
Investing is first and foremost about you and not about the investment outlets, be they financial securities, properties or even a business. That is why in paraphrasing Kennedy, I give the following advice: “Ask not whether an investment is good, for all legitimate investments are good. Rather, ask what good an investment can do for you.”
And because investing is first and foremost about you, you need to know what your goals are and quantify them. Determine the investment return you need to earn to grow the funds you have to start with (as well as the additions you can periodically make) to the future cost of your goals.
Yet, it does not end there. You will now need to temper that derived investment return with your tolerance for risk-taking.
Risks are effectively managed through portfolio diversification. The number of stocks you put in your portfolio is a direct function of the return you need to earn as balanced by the risk you are willing to take. And you need to understand that portfolio diversification is not an exercise in achieving a higher investment return for the same level of risk. Rather, portfolio diversification is achieving the same investment return for a lower level of risk.
In the paper, “A New Paradigm for Practical Application of Behavioral Finance,” Michael M. Pompian and John M. Longo came up with a novel way of assessing the level of risk-taking of individuals based on their personality. Their system was adapted from the Tieger and Barron-Tieger and Myers-Briggs Type Indicator. You may want to Google that and see if it applies to you. Or you may just approach any financial institution that conducts investment suitability tests.
Warren Buffett, Charlie Munger, George Soros, Peter Lynch and even Philippine taipans have their way of investing based on their own set of risk and return preferences. Such preferences may differ from yours. So, as Matsuo Basho advises, you do not need to follow in their footsteps for there are many possible paths that lead to similar goals. What is important is to have a goal. Otherwise, as Dan Benson alluded to, you may just achieve a big fat zero.
Be steadfast in your portfolio strategy. Do not just abandon that strategy at the first sight of losses. If you did your homework in studying investments objectively and truly believe that the value of what you bought should be higher than its prevailing market price, then you should be okay. That is why, if you should not change horses midstream, neither should you change investment strategies in the short term.
Sustainable investing, which avoids the daily stresses from monitoring the markets, is a long drawn-out process. So, if your goal is for the long-term, so should be your investment strategy.You should not time the market. You can outperform the broad stock market index like the Philippine Stock Exchange Index and the PSEi Total Return Index even without timing the market. But let us talk about this in my next article.
Efren Ll. Cruz is a Registered Financial Planner of RFP Philippines. He is best selling book author of Pwede Na! (A Complete Guide to Personal Finance) in 2004, and is the chairman and president of the Personal Finance Advisers Philippines Corporation.
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