Diversification
How many stocks to own...
by Al Levit
([email protected])
Glendale, CA (Oct. 14, 1998) -- There have been several posts recently on the Cash-King strategies board about how many stocks should be kept in a portfolio. Buried at the end of Step 3, we suggest that a Cash-King portfolio have between ten and fifteen stocks in total, "enough to provide diversity, not so many that you can't follow them all."
However, the posts that have been submitted on this subject recently have discussed portfolios much smaller than our $20,000 account. Therefore, I think some more discussion of this policy is needed. In a minute, I will expand upon what we mean we when say that ten stocks are enough to provide diversity, but first it's important to explain why I believe that a little diversity is so gosh darn critical. It goes back to the Sleep Factor, a firm part of the Cash-King philosophy.
Now, I don't think that ANY equity-based method of investing is really low-risk in the short-term, which is why we continually say that no money belongs in the stock market if you will need it in the next five years. But time is not the only factor. There are certainly some investing methods (in small caps, or that include shorting stocks) that carry more risk than others. In that context, I believe that a Cash-King approach with a dozen holdings nearly eliminates the long-term risk of being in stocks.
More specifically, I see two big advantages to the diversified nature of the Cash-King portfolio:
- No matter how strong our companies are,
something bad can and does happen to
them occasionally. When the bad news
hits, it may have a dramatic effect in an
individual stock price, but it doesn't put a
major crimp on our overall return. That
makes it a lot easier NOT to panic and
sell at the wrong time.
- Rarely, but on occasion, we will find something truly awful about a Cash-King stock and have to sell it (for example, the initial Cash-King portfolios, while they've crushed the market's return, each has had a dog that lost more than 70% of its value). This was a problem for a diversified portfolio, but it would have been an absolute disaster for a portfolio with just a few stocks.
Therefore, I believe that it's very important for a Cash-King portfolio to achieve some measure of diversification. But how much? We say somewhere between ten and fifteen stocks. We start with the Foolish Four; we always start with the Foolish Four. That provides us with four gigantic corporations that act as ballast for the portfolio. More often than not, these are out-of-favor companies that act as defensive investments in good markets and bad. So, we've got four.
We then look to add six to eleven additional companies to our portfolio, with some exposure to different industries. Please note that our Cash-King portfolio is pretty well diversified across industries. We have three high-tech companies in Microsoft, Cisco, and Intel; two pharmaceutical companies in Pfizer and Schering-Plough; two consumer-products companies in Coca-Cola and Gap; and two financial companies in T. Rowe Price and American Express. We felt this kind of spread between different industries would keep our portfolio on an even keel through choppy waters.
At present, we have thirteen holdings in our portfolio -- the Foolish Four and nine Cash-Kings. Paying an $8 commission, we shelled out $104 to get this portfolio started ($8 x 13 = $104), or 0.47% in fees. In general, we look to hold fees on a long-term portfolio to below 2% upfront. In other words, anyone with $5,000 or more could duplicate this portfolio at an online discount broker offering $8 trades. Because there are now online discounters offering $5 trades, a Fool could actually duplicate this portfolio by paying just $65 in fees, and thus could get it started with $3,500.
For those with less than $3,500 to invest, I'd suggest buying the Foolish Four first, then adding C-Ks by first considering our best-performing stocks. Yep, more often than not stock performance correlates with business performance -- so I'd be inclined to study the winners long before the losers. Imagine, for instance, if you'd methodically bought the losers in The Fool Portfolio. You might never have bought America Online or Amazon. Oops!
To close with a final example, if I had $1,500 to invest, I'd open up the $5-trade discount brokerage account, buy The Foolish Four and then add two Cash-Kings. I'd be getting six companies, paying $30 in fees, or 2% of the total account, and then I'd methodically add new money as it was appropriate.
What if everyone knew this? Well, for one thing, they wouldn't be calling The Motley Fool Radio Show to lament the broker who sold them a $5 stock, and then another, and then a load fund, and then another... and so on and so on and so on...
Fool on,
Al
Cash-King Strategy Folder
Cash-King Companies Folder
Stock Change Bid AXP +2 3/8 80.88 CHV + 9/16 84.13 CSCO +1 7/16 52.13 KO + 3/8 64.38 GPS +3 1/4 56.63 EK + 3/8 72.75 XON +1 74.00 GM +1 1/4 52.31 INTC -1 82.56 MSFT +3 3/4 100.19 PFE +8 1/4 96.25 SGP -2 1/8 95.25 TROW + 3/4 25.25 |
Day Month Year History
C-K +2.44% -4.11% 1.28% 1.28%
S&P: +1.07% -1.13% -0.04% -0.04%
NASDAQ: +2.09% -9.03% -7.52% -7.52%
Cash-King Stocks
Rec'd # Security In At Now Change
2/3/98 24 Microsoft 78.27 100.19 28.00%
2/3/98 22 Pfizer 82.30 96.25 16.95%
5/1/98 37 Gap Inc. 51.09 56.63 10.83%
8/21/98 22 Schering-P 95.99 95.25 -0.77%
2/13/98 22 Intel 84.67 82.56 -2.49%
2/27/98 27 Coca-Cola 69.11 64.38 -6.85%
6/23/98 34.5 Cisco Syst 57.56 52.13 -9.45%
5/26/98 18 AmExpress 104.07 80.88 -22.29%
2/6/98 56 T. Rowe Pr 33.67 25.25 -25.01%
Foolish Four Stocks
Rec'd # Security In At Value Change
3/12/98 20 Eastman Ko 63.15 72.75 15.21%
3/12/98 20 Exxon 64.34 74.00 15.02%
3/12/98 15 Chevron 83.34 84.13 0.94%
3/12/98 17 General Mo 72.41 52.31 -27.75%
Cash-King Stocks
Rec'd # Security In At Value Change
2/3/98 24 Microsoft 1878.45 2404.50 $526.05
2/3/98 22 Pfizer 1810.58 2117.50 $306.92
5/1/98 37 Gap Inc. 1890.33 2095.13 $204.80
8/21/98 22 Schering-P 2111.7 2095.50 -$16.20
2/13/98 22 Intel 1862.83 1816.38 -$46.45
2/27/98 27 Coca-Cola 1865.89 1738.13 -$127.77
6/23/98 34.5 Cisco Syst 1985.95 1798.31 -$187.64
5/26/98 18 AmExpress 1873.20 1455.75 -$417.45
2/6/98 56 T. Rowe Pr 1885.70 1414.00 -$471.70
Foolish Four Stocks
Rec'd # Security In At Value Change
3/12/98 20 Exxon 1286.70 1480.00 $193.30
3/12/98 20 Eastman Ko 1262.95 1455.00 $192.05
3/12/98 15 Chevron 1250.14 1261.88 $11.73
3/12/98 17 General Mo 1230.89 889.31 -$341.58
CASH $48.07
TOTAL $22069.45
*Please note: On 8/4/98 $2,000 cash was added to the
portfolio. $2,000 will be added every six months.
*The year for the S&P and Nasdaq is as of 02/03/98
