Diversifying your Equity Portfolio with Focus

How many stocks do you need to diversify your portfolio for adequate protection.  Well, it depends.  If you know what you are doing, say some, then you only need a dozen stocks or less in your portfolio.  Warren Buffett is famous for saying that “Diversification is protection against ignorance.”  We won’t get into that debate, but we tend to believe that adequate diversification can be achieved through holding the right combination of stocks with the appropriate quality, value, and financial strength.  Our flagship portfolio, The Investoristics 10, handily outperforms the index over time but what if you wanted to stay close to the performance of the S&P 500 with a little bit of outperformance? Kind of similar to an ETF fund that attempts to match the performance of the S&P 500.

The point of this exercise is to show that you can do a good job of diversifying your portfolio by holding only 10 stocks that provide the investor with a slightly higher return with lower risk than the S&P 500.  Let’s look at the statistical comparison below.  You should note that the 10-stock portfolio does slightly better than the S&P 500, 10.5% vs 10.3% over the last 18 years.  More impressive, the 10-stock portfolio has a 10% higher Sharpe Ratio (it’s less risky), had a maximum drawdown of -23.8% vs the S&P 500 which had a maximum drawdown of -39.1% during the 18-year period.  Finally, the 10-stock portfolio had 16 out of 18 years of positive returns vs 15 of 18 for the S&P 500.

So, how did we accomplish this?  We created a screen designed to choose stocks of quality businesses that were no longer in the growth phase but were still delivering a great return on invested capital for shareholders.  Again, the goal was to show that diversification can be accomplished with a very concentrated portfolio if you understand what drives your portfolio’s performance.  It’s simple, but not easy.

As Warren Buffet’s right-hand man, Charley Munger, famously said, “Take a simple idea and take it seriously.”  We get that and we believe that a stock’s price will ultimately follow a business’s earnings and earnings expectations and when that is not the case there is opportunity. Mostly everyone is in search of undervalued securities and our flagship portfolio, The Investoristics-10 (available via subscription-based newsletter), provides significantly higher returns than the S&P 500 over time with a lower risk profile.  For better performance in your equity portfolio, join “The Collective” or alternatively, just keep it simple and do it yourself.