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Why diversification in a stock portfolio? - kcchongnz
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Why diversification in a stock portfolio?
The popular adage of "Don't put all your eggs in one basket" is very much suited for investing in the stock market. It advocates diversification, a technique that reduces risk by allocating investments in a number of stocks in the portfolio. Ideally the stocks chosen should be spread over different industries that would each react differently to the same event.
For example, the portfolio of 11 stocks here consists of companies of different industries; they are construction (Pintaras), Trading and Services (Kumpulan Fima, MFCB), Consumer (Haio, Homeritz), Industrial (Fibon, CBIP, Tien Wah), Technology (Willowglen, Datasonic), and Property (Daiman). Even within each industry, the stocks there are also lowly correlated. For example for the three stocks in the Industrial category, Fibon is in advanced polymer matrix fiber composites and electrical insulators, enclosures and meter boards; CBIP in palm oil equipment and retrofitting special purpose vehicles; and Tien Wah in printing works.
Stocks diversification won’t ensure gains or guarantee against losses but strives to smooth out unsystematic risks of companies in a portfolio which are not perfectly correlated so that the positive performance of some companies will neutralize the negative performance of others.
Kumpulan Fima, one of the eleven stocks in my portfolio here was my most favoured stock. It is still my favourite now. If I were to put all my money in this stock four months ago, I would only obtain a meagre return of just 1.32% as on 11 December 2013, way under-performed the broad market. With the diversification into the eleven stocks, my return now is 32%, out-performed the market with an alpha of closed to 30% in the last four months with some luck factors.
Modern Portfolio Theory by the Nobel Laureate Harry Markowitz has shown that when you have stocks that have low correlations together in a portfolio, you may be able to get more return while taking on the same level of risk, or the same returns with less risk. The less correlated the assets are in your portfolio, the more efficient the trade-off between risk and return.
Studies and mathematical models have shown that maintaining a well-diversified portfolio of about 20 stocks will yield the most cost-effective level of risk reduction as shown in the figure below.
This principle of stock diversification will continue to guide me in my stock selection in 2014.
Posted by kcchongnz at Dec 10, 2013 07:53 PM
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Discussions
1 person likes this. Showing 34 of 35 comments
I have 15 in my portfolio but fews of them do not really requires close monitoring on its biz. Example are LPI, MBB, CIMB. GenT and GenM do not requires babysit too. So basically I pay more attetion on 10 counters only.
2013-12-10 22:45
# bsnpng - how are you ? I have slightly more than 20 in my portfolio and like you say quite a few do not require monitoring but those under short term / quick trading do need constant surveillance.
2013-12-10 22:50
inwest88 : Thanks for your greeting. I am curious if you make good money from the active trading as thread kaki932 ?
I am pretty passive all along, just Sit and Wait. Lately, I bought in MKH at the wrong timing. Still making a marginal lost. I believe it was due to the poor FCF(Ah Ha! learning from KC in talking FCF, unfortunately I am a half past six lah).
KC talked about Prestariang lately. Do you follow ? I follow the analysis but not the purchase.
Good luck.
2013-12-10 23:03
Diversification also need with margin of safety (i read from some book before, but forget what book). The idea is we make diversification only on possitive margin of safety. If we play diversification in gambling Roulette (0 to 36 number) or 4D (with ibox, or any box) its negative margin of safety that winner only depend on luck.
2013-12-10 23:12
# bsngpg - if you were to read my postings, you would know I have my own trading method in spotting counters (with a bit of TA and FA although I do not follow entirely) before others do and move in for quick fun trades (will hold on to some depending on the quality of the counter). So far so good as the success rate is about 70% - 75 % (plus or minus). After fully retired a few months back I have more time to do online trading. I do not aim to get rich but contented to earn some additional income. So far so good. The earnings can cover for my drinks and some decent meals for the family. I can't ask for more. Have to switch off - good night !
2013-12-10 23:15
Good feedback here on the number of stocks for diversification. Yes, for a retail investor, depending on the amount of money he has to invest, a portfolio of 5 to 20 stocks would be optimal. There is this economic 'Law of Diminishing Marginal Returns'.
There is no free lunch in the real world. Diversification is the only free lunch one can get in investing.
2013-12-11 06:02
Warren Buffett says, “Diversification is protection against ignorance.”
Peter Lynch has referred to diversification as “deworsification,” especially when it came to companies diversifying into non-core businesses.
Charlie Munger says “Wide diversification, which necessarily includes investment in mediocre businesses, only guarantees ordinary results.
2013-12-11 06:51
Holding multi counters as a means of diversification can bring you to be a small millionaire like me.......I have hold counters for more than 25 years......receiving dividens and price appreciations.......if you ask me I will say 20 strong counters for long and 30 for short play.....money makes more money...thats the way if you have the dough.....try
2013-12-11 06:56
"Put all of your eggs in one basket and watch it carefully" - Warren Buffett.
The "put all of ur eggs " mean not one or two eggs, already diversification ?
But normally i fail in "watch it carefully", hahaha
2013-12-11 07:03
Learn the concept and method wisely and practice those suit you the most. Should not just follow rigidly. Lee Chong Wei and W Buffet can share you their methods of successes but there is no second LCW and WB.
If you just clone whatever LCW did, you may very likely get injured very fast and unable to play badminton for long term. If you just clone whatever WB said, you may end up in Holland very fast unless there is an angel on your shoulders every day.
I like WB and LCW on their “spend lot of time, stay very focus, for very long term, watch it carefully”.
I also like “hold for >25 years......receiving dividends and price appreciations....$ makes more $=millionaire”. I screwed up my first 14 years; the counter which I hold for the longest period now is only 7 years, which is Genting.
How about you ?
2013-12-11 07:25
bsngpg, good explain. agree with u .thanks.
ur longest holding period 7 yr with good ctr (genting), then very well!!
My longest holding ctr 14 yrs, but the ctr fail! the ctr, FOUNTAIN VIEW DEVELOPMENT BHD (forget the priviuos name before rename/merge/take over) delisted rdy few yr ago. thats why i say i fail in "watch it carefully".
Lucky also i learn from that.
2013-12-11 07:42
Fountain view....I made a small fortune from this counter...lucky me....I also made some from repco/union paper/ hwa thai and a whole lot of other delisted counters......that was in 1993 super bull run...sometimes diversification into these counters will kill you......be smart and run fast if it is too good to be true.......
2013-12-11 08:19
Ah...the earlier nineties.
It was so vibrant and the market was so optimistic and naive. Almost magical tales of tycoons with midas touch, golden fingers and all that.
It was stock play in the day and party at night. Remisers and stock brokers were the most coveted occupation.
I could only watch from the sidelines.
That saved me.
2013-12-11 10:21
I wonder how many of you all still in the market since the ninties made some of us small millions.......no internet/ no on line/no cheap brokerage and still very vibrant and super deals........7 days for contra.....$ made $.........no need for blogs or silly analysts.......no need for diversitation of shares.....all ah mahs, mee goreng sellers, pork cutters and chicken egg vendors.....all buy/ sell at own risk......were you in .??????
2013-12-11 12:40
Posted by Fat Cat Tim Buddy > Dec 11, 2013 06:51 AM | Report Abuse
Warren Buffett says, “Diversification is protection against ignorance.”
Peter Lynch has referred to diversification as “deworsification,” especially when it came to companies diversifying into non-core businesses.
Charlie Munger says “Wide diversification, which necessarily includes investment in mediocre businesses, only guarantees ordinary results.
All the sayings here are from the great gurus in investing. Can't argue with them. But I think few are Warren Buffets and Charles Munger. For Peter Lynch he had hundreds of stocks at any time in the fund he managed last time.
Why is diversification (into 5 to 20 stocks)important for a retail investor? Now let us look at a stock portfolio set up 14 months ago by an ordinary investor in i3 at the appendix.
The portfolio consists 4 REITs and 12 other stocks. It returned an average of 30% in 14 months, 3 times that of the broad market. It is a great feat.
Say this guy likes REITS and he bought all REITS, the four of them and not diversifying into other stocks. What would be his return? He will make a loss of about 5% instead of the profit of 30%.
What if he had not include the few big gainers like Poweroot, Zhulian, Wellcall, Fiamma, Coastal and Astino? He would just made the market return.
Would he be so lucky that he just bought those big winners and made huge returns? I think it would be unlikely.
It was so happened that it was a up market for the last 14 months. What happen if it were a bear market? Could one know the market if bull or bear in advance 14 months ago?
So does diversification work?
Appendix
Reference date 12/10/2012 11/12/2013
Stock Name Ref Price Price now Change %change
Ambank 6.36 7.43 1.070 16.8%
Astino 0.83 1.17 0.340 41.0%
CMMT 1.75 1.40 -0.350 -20.0%
Coastal 1.80 3.3 1.500 83.3%
Fiamma 1.16 1.88 0.720 62.1%
Haio 2.06 2.6 0.540 26.2%
Jaycorp 0.485 0.585 0.100 20.6%
Marco 0.15 0.15 0.000 0.0%
PPBank 14.56 15.38 0.820 5.6%
Stareit 1.04 1.01 -0.030 -2.9%
Twerreit 1.45 1.50 0.050 3.4%
UOAreit 1.440 1.45 0.010 0.7%
Wellcal 2.370 3.53 1.160 48.9%
YSPSAH 1.070 1.30 0.230 21.5%
Zhulian 2.560 5.00 2.440 95.3%
Poweroot 1.020 1.83 0.810 79.4%
Average return 30.1%
dividend 3.0%
Total 33.1%
2013-12-11 12:57
the biggest problem for me is not so much on diversification on how many stocks but how many % to allocate to stocks vs cash as a whole during a given time... should I do market based portfolio balancing or fixed schedule portfolio balancing... don't want end up with no cash once the opportunity arises...
after all if you have a very nice portfolio of stocks which gives you a return that beats the index but only allocated 30% of your total cash into those stocks then the overall return for yourself is still low....
2013-12-11 13:14
Holding multiple counters as a means of diversification is workable.....good dividen shares should be kept on hold......like zhulian/deleum/bat/carlsberg/aeon..........if the market reverses and you make 200 % already......change the counter......and you must have 20k for standby if you are playing 60k.........get it????????
2013-12-11 13:52
diversification works (if you have deep pockets ) and invest long term ( meaning ( 1 to 2 years )holding powers. for the average players ( average 6-8 counters ) is sufficient.
maybe 1-2 banking counters, 1-2 property counters , 1-2 plantation counters plus 1-2 trading position. market plays on themes. this is just my personal opinion.
2013-12-11 14:02
All gurus here sharing. Good to be here. :)
#bsngpg, hows ya? It has been a while since we last chat.
2013-12-11 17:08
Hi Eric Wong: I am still surviving in my career and Bursa and the same as before-the passive player in the market. Lately I have no any action except buying in some MKH while studying Prestariang for future. How about you then?
2013-12-11 20:55
# bsngpg - sorry, missed out your question. No, I did not go into Prestariang.
2013-12-11 20:59
Hi inwest88: Recommend you to study and follow up Prestariang. From the preliminary study, it should be a good candidate for long term and dividend. KC talked about it and bought in.
I do not want to chase after. Sit and Wait for opportunity to knock the door.
CEO(Dr Abu Hasan Ismail) aims to bring Prestariang market capital to RM1 bil in 3 year time from the current around RM550m. RM5 in 3 years ? Do you buy his aspiration/aim?
2013-12-11 21:19
# bsngpg - thanks. I have seen the write-up bu KC. Same with me - waiting for the right moment
2013-12-11 21:25
# bsngpg - i add on some L&G-LA before it started rise. Others still remain same as i showed to you my portfolio last time. :)
I'm still study on the financial statements and refer to kcchongz. Now study and monitor JCY and Notion WB.
2013-12-11 21:35
Hi Eric : Aiyoh , my dear friend, while most of the people try to avoid HDD, you chose two counters on HDD. I salute you. Do you know that as at today I made a very significant return on all counters bought in 2010 as the index then was very low. There is only one exception which is Notion, not to mention profit; I am still making 34% loss from the day I bought in 2010. Why don't you chose Prestariang?
2013-12-11 22:47
I just surfed thru Prestariang which kcchongz posted last week. Will look into it again. Thanks.
Haha, know the market not really into HDD now, i dunno, just monitor and cc. :)
2013-12-11 22:58
Hi Eric: Somebody talked great about Inari, I do not want to study it due to its low end electronic mfg services industry and ACE mktg. But there was one interesting thing that it's CEO has very ambitious aim to grow the company to very big in foreseeable short timeframe. . Do you study this one too? I am not. Good luck. It is nice to talk to you. Bye.
2013-12-12 07:00
My friend also intro me this ctr half year ago when it still at 0.6 price but still i didn't look into it. I know its very hot now, just under monitoring list. :)
2013-12-12 13:16
From the Motley Fools:
There's a scene in the documentary Enron: The Smartest Guy in the Room where Enron's HR director is asked by an employee in a 1999 meeting, "Should we invest all of our 401(k) in Enron stock?"
The HR executive laughs and blurts out, "Absolutely!" And I'm sure she meant it.
Enron stock made up more than half of Enron employees' 401(K)s when the company went bankrupt a year later, according to FINRA. Employees not only lost their jobs, but half their retirements.
Warren Buffett once said, "Diversification is protection against ignorance. It makes little sense if you know what you are doing." But a lot of investors not named Warren Buffett don't know what they're doing, and Buffett's own Berkshire Hathaway controls 55 subsidiaries in industries ranging from underpants to private jets, newspapers to industrial chemicals.
William Goetzmann of Yale once analyzed the portfolios of 60,000 investors and wrote: "The least diversified (lowest decile) group of investors earns 2.40% lower return annually than the most diversified group (highest decile) of investors on a risk-adjusted basis."
I think every investor should own at least 10 companies, if not more, from a wide range of industries. It's how you protect your wealth from the unknown. As financial planner Carl Richards puts it, diversification "means that you're willing to exchange the opportunity of making a killing for the assurance of never getting killed."
2013-12-14 12:18
Diversification in stock portfolio still the MUST HAVE..... We cant predict any company always doing well forever....sometime we can be very wrong after purchase a 'good' counter ....'undervalue' companies also can be 'overvalue' in overnight time....
Another good rules : minimum 25% to maximum 75% in stock, others must be in cash. If our portfolio double in value, sell some percent(almost 13% current value) to maintain 25% in cash, no matter how good our holding counter future prospective.
2014-03-09 23:05
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bsngpg
20 counters are a bit too many for me to monitor their business development.
2013-12-10 22:37