A financial journalist, Sandy F., saw a few of my Forbes articles and started corresponding. She read my latest post on “Salad Bar Investing” and came back with a good, practical question. Here is our exchange.
Question from Sandy F.
Hi Erik-
Thanks for a great article on salad bar investing. I am so guilty of that! I appreciate your recommending a thoughtful, value based alternative.
How many stocks do you recommend in a portfolio? I’ve always been more partial to stocks than ETFs. Perhaps it’s time to change.
Sandy
Erik’s Answer
Hi Sandy,
Thanks for the mail…
Human beings are not very good at making decisions. One of the courses that I have online (“Framework 101”) deals with the “behavioral biases” we bring to decision making that make it hard for us to make consistently good, rational decisions and stick with them. Also, humans can’t hold a lot of stuff in their brain very well. One of my portfolio managers had a list of around a dozen stocks that he knew very well, and a lot of his (long and mostly-successful) career involved moving in and out of those stocks as the price-to-value relationship changed.
For me, I think that having exposure to a broad market portfolio through an index (or “super-index” if you believe in such things) plus a maximum of five or six single-name stocks makes a pretty strong portfolio. You get efficiency from the index portion and the remaining handful of stocks is low enough in number, you can tell when you’re right or wrong about them. This is precisely the opposite of what the Investing-Industrial Complex tries to convince investors: “You need a lot of ideas, frequently.” The fact is, most people providing financial advice are compensated, in one way or another, by volume or flow, so they would rather traffic in quantity than quality!
I love this quote from Buffett:
If you can identify six wonderful businesses, that is all the diversification you need. And you will make a lot of money. And I can guarantee that going into a seventh one instead of putting more money into your first one is gotta be terrible mistake. Very few people have gotten rich on their seventh best idea. But a lot of people have gotten rich with their best idea. So I would say for anyone working with normal capital who really knows the businesses they have gone into, six is plenty, and I probably have half of what I like best. I don’t diversify personally.
Thanks for the question! Are you getting a picture of where I’m going with this?