One stock portfolio

November 26, 2012, 3:21 pm Marcus Padley Yahoo!7

How doing the opposite of diversification can make you an expert trader.

Captain Cook, the first of a long line of successful English captains to tour Australia, will tell you one certainty of life. Discover any group of human beings, no matter how remote, and they will have a God and a religion. It was not someone’s idea, it is a human need, to huddle under an omnipotent being and a connected creed. To have all our biggest questions in life, any question in life, answered not by logic, but by faith, in a guru and his teachings.

Net result, from religion to financial advice, our insecurity endows our symbols with vastly more trust and belief than they could ever realistically possess or deserve. It has been going on since the depths of time. Blind faith born of insecurity and in the complex wilderness of financial theory we have a lot of gurus but one religion. It’s called diversification.

We have all heard the cry. A spread of equities, bonds, property and cash. A spread of international and domestics investments. A spread of sectors including resources, financials and industrials. In fact, by the time you leave the average financial planner you may think you’ve bought 6 managed funds, but in fact you have a portfolio of 14 asset classes and 3,000 stocks domiciled in half a dozen countries.

But those 3,000 stocks won't save you in a bear market and will dilute your returns in a bull market. It is the “Chicken little” approach and worse than that it fools you into thinking you are safe. It is a “Matrix” that prompts laziness and inattention and on that basis diversification is actually more risky because it instills apathy and a false sense of security. There is no security in the current market. There is no comfort in historic returns and there is no refuge in holding everything. We are in a market that is down 40%, down 9.6% per annum for five years, it is a dangerous market and we need to do better than hide in an inappropriate theory that suits the industry more than it suits the customer.

So let’s depart for a moment. Cut across all the consensus preaching and consider a blasphemy of accepted financial indoctrination. The opposite of diversification, I call it the “One stock portfolio”. Last time I wrote about it my broker added “Marcus’ views do not represent ours” to my articles. But they need not have worried, it is just an idea to focus the mind and make a point.

Imagine if you had a $1m super fund invested in managed funds or, more commonly, in the standard twenty stock diversified portfolio you look after yourself. Now imagine you sold everything and put the $1m into one small industrial stock. What would happen? I’ll tell you.

You would find out everything you could about that stock. You would ring the management. Go and see the company. Find any research you possibly could. With one hours work you’d be in the top 0.1% of people who knew anything about that stock. With ten hours work you’d be in the top 0.000001% of people who knew anything about that stock.

You would watch the share price every second of the day. You would question every fluctuation. You would develop trading skills, a stop loss mechanism. You would learn all about its volatility, trend, habits and nuances. You would watch it like a hawk, spruik it mercilessly and if anything went wrong you wouldn’t tell anyone you’d just sell. Over time you would have a sixth sense about where the share price was going and you’d take advantage of it. You would become ‘the expert’.

Now you have to ask, what’s more risky? Knowing a little bit about twenty stocks you’re not watching or everything about one that you are. “Diversification is insurance against ignorance” for people who don’t know what they are doing. But what if you're not ignorant? What if you do know what you are doing?

Trading one stock is more intense, it focuses the mind. You pay attention and paying attention is good. You do a lot more work before you buy. You think harder about every trade. You plan. You set levels. You develop a strategy. You are more disciplined, more vigilant. With so much at stake you are more risk averse, not less, you have to be. You are sensitive to bad news. You are in touch. With one stock, trading is not necessarily more risky at all or more short-term. It is less risky because you have your head in the game.

And you will hone your trading skills. You will sell instead of prevaricating. You will control the outcome rather than leave it to luck and the long term. And you will do something that the managed fund investors never do, regularly cash out. You will find that cleansing, entering the eye of the storm. Clarity returns. The world is at your feet and you then have the time and the cold emotion to put your total effort into something too few of us spend any time doing, looking for the best single investment in the whole world at that moment in time.

One good stock. As Mae West says “Too much of a good thing can be wonderful”. Now do that twenty times. Do that every time.

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e.g. BHP, CBA
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