Reflection After 3 Years 7 Months in The Stock Market

In 2007, legendary investor Warren Buffett made a $1 million bet against Protégé Partners that hedge funds wouldn’t outperform an S&P index fund, and he won.

Buffett’s choice fund, the Vanguard 500 Index Fund Admiral Shares, returned 7.1 percent compounded annually, while the basket of hedge funds his competitor chose returned an average of only 2.2 percent, the Wall Street Journal reports.” – CNBC

So basically, I knew that if I cannot beat the S&P 500 return over the long run, it’s better if I just invest in the S&P 500. While the S&P 500 practices in a huge diversification of 500 big companies listed in the U.S., my U.S. portfolio practices concentration of ideas in which I am most certain about. So here’s what you might want to think of doing: if you are passionate about investing, researching companies and simply love the idea of stock investing, practice concentration of your portfolio holdings. It works.

“Diversification is a protection against ignorance. It makes very little sense for those who know what they’re doing.” Warren Buffett.

“The appeal of a concentrated portfolio is that it is the only chance an investor has to beat the averages by a noteworthy margin” Frank Martin

While most of the investors would benefit more from investing in the S&P 500 over time, for some, if they would like to beat the market, having a concentrated portfolio helps. The investment idea has to make sense for us. Because investment is most intelligent when it is most businesslike. What is a concentrated portfolio like? I usually hold no more than 4 to 5 stocks with 1 to 2 consisting of nearly 50% of my portfolio. Apparently, I just found out that Charlie Munger thinks that it is alright to do so.

“Charlie Munger considers that a portfolio of four stocks is a well diversified portfolio. He says, you don’t even need a 5th stock. He goes on to say that if you lived in a small town, and if you owned the best apartment building in town, if you owned the highest quality office building in town, if you owned the McDonalds franchise in town, if you owned the Ford dealership. if you owned this collection of assets, even though they’re all geographically concentrated, his perspective is that you will do very well. You will not need to do much else beyond that to have an interesting investing career.” Mohnish Pabrai

Selling options and being fearful when others are being greedy and being greedy when others are fearful pays off. Options selling is a concept which explains why the one getting rich are the one who sells insurance and not the one getting insured. In practice, it is harder than in theory. Often times, we sell put options at a price which is too high influenced by the greed of getting more premiums but the key here is still the analysis & valuation. Being prepared to buy the stocks with cash ready is an important aspect of selling put options similar to providing insurance policies – having the cash in hand to pay the claims is crucial.

Here’s another takeaway for you: stay conservative. With your analysis & valuation that forms the bedrock of your investment thesis, you need to implement a suitable margin of safety in both the buying and the selling process. This way, you are being conservative and chances are, you will be better off over the long run. How so? By implementing a margin of safety in our investments, we are essentially saying that mr market can be greedy and fearful by a huge margin, so we need to take advantage of those well. That means we should buy only when it is suitably low and sell when it is suitably high. Of course, both art and science are involved, that’s what makes investing so dynamic and fun.

In conclusion, we do not know when the stock market is going to crash. But only the fool try to predict. The wise will control what he or she knows and take action on it. That means, I believe that the stock price will not stray too much away from fundamentals over the long run, but hopes and dreams can stretch stock price away from fundamentals over the long run. So buy and sell with discipline with fundamentals in mind and I do not really care when the next stock market crash is going to happen. Because I always cash on hand too when the time comes. You should too?

Actionable steps:

Learn more about the art of stock picking as well as the mechanics of the S&P 500. See what makes sense for you.

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