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Single and Most Overlooked Factor That Would Determine If Your Portfolio Becomes 10x...Or Remains Stuck at 3x - Views on News from Equitymaster

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Single and Most Overlooked Factor That Would Determine If Your Portfolio Becomes 10x...Or Remains Stuck at 3x
Apr 2, 2018

Buffett, Munger, Peter Lynch, Walter Schloss...

These legendary investors share some common traits that have made them beat markets consistently. Reams have been written over such qualities.

Yet, there is an aspect where their approaches are as opposite as North and South Poles.

And it is this differentiating trait that has been crucial to their outperformance.

You see, there are two elements to huge returns. First - the stock selection process. Second - Bet size (allocation).

Concentrated Vs Diversified

When Buffett was managing less capital, his top five holdings comprised over 90% of his portfolio. He was a typical concentrated investor. Given his investing acumen and stock selection skills, no wonder he killed the Dow.

That said, investors like Peter Lynch and Schloss never believed in concentration. At the peak of his career, Peter Lynch's portfolio had over 1000 stocks. And yet, their track record remains enviable.

A concentrated investment in winning stocks can make your portfolio outperform by a wide margin. But what if one of your bets fails? Would not that be a fatal mistake? Is it worth the risk?

In the famous book Concentrated Investing, the authors share an interesting analysis by Elton and Gruber. It quantifies the effect of diversification on risk. Risk here measures the deviation of the portfolio return from market return. This means that a portfolio with just one security will have highest risk. Further, a portfolio with all the securities trading in the market will have zero risk.

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