#TBT: 'Focus Investing' for the Average Investor
Just about every person on Wall Street, or in the broader financial world, had read some sort of publication or essay by Warren Buffet. For those of you who vaguely recall the name, Buffet is the CEO and Chairman of Berkshire Hathaway and his net worth is approximately $67 billion -- making him one of the richest people in the world. At the same time, Buffet is dubbed the "Oracle of Omaha" due to his exceptional investing skills and ability to piece together solid, long-term trends well before anyone else can catch on.
This is how he makes his billions - zeroing in on companies of exceptional significance.
An investing program once asked him if he preferred "active" (a portfolio strategy where the manager makes specific investments with the goal of outperforming an investment benchmark index) or "index" (or passive investing through the use of mutual funds) as an investing strategy?
Buffet said he preferred to use a third option - "focus" investing.
Focus investing is a term coined by Buffet to describe the process that made him so rich. Aside from the obvious, it's actually a strategy that I personally use and highly recommend that ALL investors use. This is a process that should easily appeal to my Millennial friends, especially since this is a great way to ensure that you are doing good for the world through socially responsible investing, plus it's an easy strategy that literally anyone can do.
However, it requires a lot of patience and a modest amount of research. Below are the 5 major factors that make up "focus" investing, and honestly these speak for themselves...will they make you as rich as Warren Buffet? Who knows!
1. Risk management can offset the effects of a lack in diversification
Modern Portfolio Theory suggests that you need to have X number of holdings in each major stock sector in order to diversify your portfolio enough to eliminate firm-specific risk. However, this is not necessarily the case. It is possible for people like environmentalists to completely eliminate an entire stock sector (like Energy) and still gain long-term returns. How? By focusing your efforts on minimizing risk in all other sectors by holding less-risky stocks. Ultimately upping your game in risk management can substantially make up for not having a diverse portfolio.
2. Rely on a relatively small number of holdings
In the same sleeve as above, quality outweighs quantity -- a bunch of risky stocks will not necessarily perform better long-term than one or two quality names. The "optimal" portfolio suggests that you hold approximately 70 stocks. Relatively speaking, this strategy suggests that you hold 20-30 stocks for optimal results.
3. Use a long-term holding period
There is no day-trading with a focus strategy -- you must follow a hunch you have and keep the focus on that long-term strategy, not take advantage of jumps or drops in the stock price. This is really the Ron Popeil strategy: set it, and forget it.
4. Accept volatility
Because this strategy is long-term, you are accepting and embracing all of the volatility periods that come with holding a stock for long-term growth. Meaning if you buy a stock like Target (TGT) for steady long-term growth but after an earnings call the stock loses 10% of its value, you accept a bump in performance and move on. There is no room for panic and selling before you're ready or before you should. It takes a lot of skill, but one must learn to embrace volatility.
5. Ensure that you are able to fully understand what each company does
Most importantly, you need to know and understand exactly what every company in your portfolio does, what they make, what they do, who their market is, who is their CEO and does the public/the company like them, etc. Management competence is extremely important in determining the long-term health of a company. Many people will blindly take stock advice from "experts" but never fully do their own research. This is how all the brokers in "Wolf of Wall Street" got rich -- investors were ignorant of what they are buying. If you don't understand what the company does, DON'T buy it. Period.