The #1 Rule To Building a Winning Portfolio

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The #1 Rule to Building a Winning Portfolio

Success starts with one thing - focus!

INTRO

Success starts with one thing - focus. And nowadays it seems that most people just don’t have enough of it. As we've detailed before, investing is an art. You're unlikely to achieve the same results of some of the far more accomplished, legendary investors out there simply by mimicking their every move or copying their investment portfolios. However, we can certainly leverage some of their techniques to our advantage.

If you have ever:

• wondered why you’re not progressing,

• felt tired from too many side gigs,

• raged over failed investments,

…this article is for you.

How to Take Control

Nowadays, it seems that most people can’t even pick up a book. With attention spans compressed stemming from distractions by varying social media feeds and a multitude of online news outlets, our ability to focus becomes compressed. But that shouldn’t be the end of it.

Every single successful investor or entrepreneur that I know has an insane focus. Instead of juggling 10 moderate projects, they focus on one awesome project that can be highly successful. Take a look around you. Jeff Bezos made a ton of money with Amazon. Mark Zuckerberg focused on Facebook alone, even though he could have started a second business in a heartbeat.

So how do you take control in a way that allows you greater focus and greater earning potential?

Firstly, write down all your projects and rank them by how much happiness they bring you. If you love what you do, you'll never work a day in your life.

Secondly, rank these projects by their earning potential. If it doesn’t bring you money, it’s a hobby. The project with the highest score is where you should focus. That being said, this is still an investing newsletter…

Why Investors Concentrate

As investors, Warren Buffett and Charlie Munger kept their investment portfolios focused on a limited number of companies. This allowed them better control over those portfolios and better ability to effectively monitor the financial performances of the companies within the portfolios.

If you’ve read my work before, you know I love examples. Let’s look at Warren Buffett and his $AAPL stake. By the end of 2023, Berkshire Hathaway held about a 6% stake in Apple, valued at $174 billion, which accounted for approximately 40% of the conglomerate’s total value.

This stake was four times larger than Berkshire’s second-largest public stock holding, Bank of America, and positioned Buffett as Apple’s second-largest shareholder, just behind Vanguard. The bet on Apple and CEO Tim Cook has paid off handsomely for Buffett.

In 2022, Buffett disclosed that Berkshire’s initial cost for the Apple stake was only $31 billion. Since the beginning of 2016, Berkshire Hathaway has seen its investment in Apple appreciate more than 620%. On top of that, Berkshire Hathaway earns approximately $789.4 million in annual dividends from its Apple investment.

The lesson: Legendary investors don’t diversify too heavily.

 “Keep all your eggs in one basket, but watch that basket closely.” -Warren Buffett

Still don’t believe me? Here is more proof.

Learning under legendary investor Phil Fisher, Buffett reduced the number of companies whose stock he owned. Fisher always said he would rather own shares in a few outstanding companies than in a larger number of average businesses. As a whole, Fisher's portfolios tended to include fewer than 10 companies, with 3 or 4 companies representing nearly 75% of his portfolio.

Warren Buffett doesn’t just apply this principle to investing. As you may know, Berkshire Hathaway owns multiple businesses outright, each with its own CEO. These managers are expected to focus on the businesses they know best, allowing Warren to concentrate on what he excels at: investing. Buffett doesn't encourage managers of the companies he owns to diversify.

That being said, you must be wondering…

Isn’t Diversification Safer?

Yes, that's right. Diversification is largely safer— if you're satisfied with average results. But if, like me, you aim to outperform the market, you've got to take decisive action on a limited number of companies about which you've done substantive research, thereby providing you with tremendous confidence in these as investments.

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The truth is, diversification loses its impact after holding 15-20 stocks. Owning more doesn't decrease risk; it just limits your upside potential. Diversification is a useful technique, but I've learned that diversification is no substitute for having a thorough understanding of your investments! 

In my view, the primary way to minimize investment risk is to always do your due diligence and adequate research upfront, and have strong firsthand knowledge of your investments.

According to his book Principles, investor Ray Dalio says that the quality of an investment portfolio (measured by the amount of return relative to risk) will improve incrementally if investments are added with different risk correlations. But the addition of such investments only add value to a point.  

‍Ray Dalio established The Holy Grail, confirming that 15 to 20 good, uncorrelated return streams can dramatically reduce risk without reducing expected returns. Any additional investments to the portfolio beyond that level could still be beneficial, but there is diminishing value of their impact as the number increases.  Read more in my previous write-up here: Optimal Investment Diversification.

Conclusion

Never own more than 20 stocks at one time!

If you're going to pick individual stocks for investments, we recommend an investment strategy of focused investing. As highlighted in this article by Business Times, The Five Principles of Focused Investing offers a simple guide when it comes to investing:

1. In-Depth Research and Understanding: Focused investing emphasizes thorough research and a deep understanding of a select number of investments. 

2. Concentrated Portfolio: Focused investing involves building a concentrated portfolio with a limited number of carefully chosen investments. 

3. Long-term Horizon: Focused investing encourages a long-term perspective.

4. Conviction and Discipline: Conviction and discipline are central to focused investing.

5. Risk Management: Focused investing places a significant emphasis on effective risk management.

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Information provided on this site is based on my own personal experience, research, and analysis, and it is not to be construed as professional advice. Please conduct your own research before making any investment decisions.  I am not a professional financial advisor, stockbroker, or planner, nor am I a CPA or a CFP.

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