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A policy of 'forced displacement' can help you focus your portfolio.
By Kevin Godbold
If, like me, you desire to own a concentrated portfolio of investments, and wish to abstain from introducing new cash into your portfolio, it can make a lot of sense to adopt a policy of forced displacement.
In other words, if you are fully invested with your maximum number of holdings in place, buying a new investment means that you have sell something you currently own!
Concentration
About two years ago, I decided to work towards concentrating the investments within my portfolio to a maximum of ten holdings.
The decision to concentrate was a product of previous bitter experience. In the past, even though I thoroughly researched each of them before buying, I ended up with far too many shares. It was hard to follow them all in sufficient depth and with sufficient focus, and my performance suffered as a result.
Warren Buffett once frankly stated: "Diversification is a protection against ignorance. It makes very little sense for those who know what they are doing."
He also said, rather more kindly: "Risk can be greatly reduced by concentrating on only a few holdings."
I would add that risk only has a chance of being reduced if fewer holdings leads to greater concentration of thought and focus on your investments.
No new money
As well as concentrating my investments, I decided long ago that no new cash would go into my portfolio (honestly, that was my own decision and not the wife's!).
It seemed to me, that through compounding, it would be possible to grow even modest sums into not so modest sums over the long term. For example, starting with an initial investment of £20,000 and compounding it at 10% for 25 years would give you around £217,000.
Compounding could potentially be achieved by reinvesting dividends and recycling maturing investments into new ones.
The dilemma
All of that works fine until you find yourself fully invested and coveting some sexy new investment that you have thoroughly researched.
Then is the time to be very firm about your investment rules. It would be tempting to sell bits of this and bits of that to fund a new position, but that could mark a return to the bad old days of diluting the portfolio into smaller positions.
You must be ruthless -- if you want to own a slice of the new company, one of the existing holdings has to go.
At that point, you are weighing up the relative merits of one company already in your portfolio, against another that wants to replace it: a potentially more intense exercise than analysing a company's prospects in isolation and then just buying it. It really focuses your mind!
A well-trodden path
Several well-known successful investors have practiced forced displacement in the past.
For example, in Alice Schroeder's biography on Warren Buffett, The Snowball, she quotes him as saying, when talking about his investing in the early 1950s: "I was already running short of money to invest. If I was enthused about a stock I would have to sell something else to buy it."
And, in his book Beating the Street Peter Lynch Says: "Most of my abrupt changes in direction were caused not by any shift in policy but by my having visited some new company that I liked better than the first... In order to raise the cash to buy something, I had to sell something else..."
In my view, in order to be successful, the forced displacement technique must be considered as a kind of 'weapon of last resort' for your portfolio. You do not want to slip into overtrading, with all its associated costs.
If applied properly, it should promote even greater focus and intensity of thought when evaluating an investment opportunity, as to invest also requires you to divest.
Published in Investing Strategy on 19 July 2010
http://www.fool.co.uk/news/investing/investing-strategy/2010/07/19/how-to-force-yourself-to-be-a-better-investor.aspx
By Kevin Godbold
If, like me, you desire to own a concentrated portfolio of investments, and wish to abstain from introducing new cash into your portfolio, it can make a lot of sense to adopt a policy of forced displacement.
In other words, if you are fully invested with your maximum number of holdings in place, buying a new investment means that you have sell something you currently own!
Concentration
About two years ago, I decided to work towards concentrating the investments within my portfolio to a maximum of ten holdings.
The decision to concentrate was a product of previous bitter experience. In the past, even though I thoroughly researched each of them before buying, I ended up with far too many shares. It was hard to follow them all in sufficient depth and with sufficient focus, and my performance suffered as a result.
Warren Buffett once frankly stated: "Diversification is a protection against ignorance. It makes very little sense for those who know what they are doing."
He also said, rather more kindly: "Risk can be greatly reduced by concentrating on only a few holdings."
I would add that risk only has a chance of being reduced if fewer holdings leads to greater concentration of thought and focus on your investments.
No new money
As well as concentrating my investments, I decided long ago that no new cash would go into my portfolio (honestly, that was my own decision and not the wife's!).
It seemed to me, that through compounding, it would be possible to grow even modest sums into not so modest sums over the long term. For example, starting with an initial investment of £20,000 and compounding it at 10% for 25 years would give you around £217,000.
Compounding could potentially be achieved by reinvesting dividends and recycling maturing investments into new ones.
The dilemma
All of that works fine until you find yourself fully invested and coveting some sexy new investment that you have thoroughly researched.
Then is the time to be very firm about your investment rules. It would be tempting to sell bits of this and bits of that to fund a new position, but that could mark a return to the bad old days of diluting the portfolio into smaller positions.
You must be ruthless -- if you want to own a slice of the new company, one of the existing holdings has to go.
At that point, you are weighing up the relative merits of one company already in your portfolio, against another that wants to replace it: a potentially more intense exercise than analysing a company's prospects in isolation and then just buying it. It really focuses your mind!
A well-trodden path
Several well-known successful investors have practiced forced displacement in the past.
For example, in Alice Schroeder's biography on Warren Buffett, The Snowball, she quotes him as saying, when talking about his investing in the early 1950s: "I was already running short of money to invest. If I was enthused about a stock I would have to sell something else to buy it."
And, in his book Beating the Street Peter Lynch Says: "Most of my abrupt changes in direction were caused not by any shift in policy but by my having visited some new company that I liked better than the first... In order to raise the cash to buy something, I had to sell something else..."
In my view, in order to be successful, the forced displacement technique must be considered as a kind of 'weapon of last resort' for your portfolio. You do not want to slip into overtrading, with all its associated costs.
If applied properly, it should promote even greater focus and intensity of thought when evaluating an investment opportunity, as to invest also requires you to divest.
Published in Investing Strategy on 19 July 2010
http://www.fool.co.uk/news/investing/investing-strategy/2010/07/19/how-to-force-yourself-to-be-a-better-investor.aspx
