Canadian Focus Investors
1
Focus on Few Companies
This worshipping at the altar of diversification,
I think that is really crazy.
1
Charlie Munger
Some diversification of your holdings is recommended, even with a focus investing strategy, so that if one company is financially unsuccessful or goes bankrupt, only a portion of your retirement savings will be affected. It is certainly the case that if you only held one or two companies in your portfolio, and you were absolutely certain they would contine to pay a very high and growing dividend for the next several decades, you would eventually realize an exceptionally high dividend income stream. Of course if one or both companies failed, you would loose a significant portion of your retirement portfolio, which is why holding a very small number of companies is not recommended.
An important question then, is what is the minimum number of companies you should hold in your portfolio, so that you can maximize your dividend income and still be protected from a major loss, if one of your holdings becomes insolvent?
We can get some idea of the minimum number of companies you should hold in your portfolio, by referring to the number of companies held by Warren Buffett and other successful money managers, as reported by (Hagstorm,1999) and summarized in the following table. The table also includes the number of companies held in large investment funds that were managed by three other money mangers who achieved exceptional returns, as reported by Benello et al. (2016).
As indicated, these managers held anywhere from 5 to 30 companies in the large investment funds they managed. It also of interest, that these managers made no attempt to equalize the proportions the fund's assets held in each company. Quite the opposite, since some managers concentrated most of their fund's assets in just 2 or 3 companies, with smaller amounts allocated to the other companies in the funds.
The minimum number of companies you hold in your portfolio will depend on how confident you are in the financial stability and financial prospects of each holding. It is therefore essential to undertake a careful review of each company's financial performance, particularly during historical economic downturns. In addition you should assess the competance of the current management team, the stabililty of the each company's ongoing operations and the soundness of managment's future plans. Such assessments will necessarily involve some level of uncertainty. Therefore, once you have taken a position in a company, it is important to monitor its financial performance several times each year, or whenever you hear of an event that could have a negative effect on the company's long term financial prospects.
There is a trade-off between the number of companies you hold in your portfolio and the time required to learn as much as possible about the company and monitor its financial performance regularly. Many folks who have a career and family commitments, in addition to their investing activity, find that they can successfully manage somewhere between 5 and 15 different companies. In my case, I found that I could easily manage 10 different holdings, as listed on the section About Me.
If your portfolio currently holds mutual funds or exchange traded funds, and you are thinking of changing to a focus investing strategy, I recommend that you begin by keeping the bulk of your portfolio in the funds you currently own and set aside a small portion (say 5%) of your savings for buying the common shares of 1 or 2 financially stable companies that offer a signficant dividend yield and have a record of dividend growth. After several months, as you gain confidence in your ability to select and monitor these companies, you can add additional holdings to your portfolio.
It is important not to rush your decisions and it may take one or two years before you have completely converted your investments to a focus investing strategy. It is not necessary to set a time frame for the conversion, however, in order to avoid procrastination, I suggest you set a target date of 12 to 18 months hence, to complete the conversion of your portfolio from managed funds to individual companies.
It is possible that you find that you cannot devote sufficient time, or that you simply do not enjoy managing your investment portfolio. If that is the case, you can decide leave the management of your investments to others, and invest once again in managed funds. No harm, no foul.
1. Clark, D., 2017. The Tao of Charlie Munger. A Compilation of Quotes from Berkshhire Hathaway's Vice Chairmen on Life, Business, and the Pursuit of Wealth. Simon and Shuster, New York, NY.
2. Benello, A.C., Van Bieman, M., and Carlisle, T.E., 2016. Concentrated Investing, Strategies of the World's Greatest Concentrated Value Investors, John Wiley & Sons, Inc., Hoboken, NJ, p.106
3. Hagstrom, R.G., 1999. The Warren Buffett Portfolio, Mastering the Power of the Focus Investing Strategy. John Wiley & Sons, Inc. New York, NY pp.40 to 58