We already own three companies in which we are investing steadily. Are three large industry leaders enough for a long-term investor?
The immediate response of many investors is likely to be a resounding, "No! Three stocks do not provide enough diversification! A portfolio should hold at least eight stocks, and typically more than twelve."
We have always said that our portfolio would hold six to eight stocks total, but six at most is the likely number. Perhaps three would do it, however. If chosen well, why not?
When you invest for the long term in a larger handful of companies (say 12), it is still likely that just one or two companies will come to represent a majority of your wealth. At times, America Online (NYSE: AOL) has represented 50% of the Rule Breaker Portfolio's net worth, thereby making AOL largely responsible for the portfolio's great success. This being the case, disparaging the AOL position as "too large" is counter-intuitive and illogical.
In another example, Coca-Cola (NYSE: KO) has represented nearly 50% of Warren Buffett's net worth in years past. Plus, if he had initially bought more Coca-Cola and fewer other companies that have since underperformed Coke, he would be doing even better. Can you argue with numbers? Not in the end. Growing just one number (your net worth) is the raw goal of all investing.
So, suppose that we don't find any companies that we like better than those that we already own. Suppose we only find companies that we like just as much. In this case, should we buy the new companies? If we did, it would mean more accounting and tax work, and it would create a need for increased knowledge and continued maintenance of that knowledge; it would also expose us to any risks that our newest investments face, and it would divert investment funds away from our current holdings -- holdings in businesses that we understand very well, and holdings with averaged cost-bases that are largely favorable.
On the other hand, buying more stocks would diversify our holdings. Note that this means diversifying risks, not avoiding risks. Buying more stocks would also expose us to whatever opportunities our new investments possess. If those opportunities are greater than the opportunities offered by our current holdings, investing in the new companies would make sense. However, if -- as we're imagining -- the opportunities presented by new companies appear to only equal the opportunities of our current holdings, why buy them?
What do you think? Are we on solid, market-beating ground owning Johnson & Johnson (NYSE: JNJ), Intel (Nasdaq: INTC), Mellon Bank (NYSE: MEL), and -- to a lesser extent -- Campbell Soup (NYSE: CPB)? Should we keep our costs at zero, solely growing our knowledge of what we own and continuing to invest our money where our mouth has been? Or do we need to find others? Do we need to invest in an oil giant, for example, because it could outperform our three largest holdings over the next 17 years?
Before you think about answering the question -- the question of "Do we still need to add more companies to the portfolio?" -- let's review some pros and cons:
Positives of not buying more stocks:
- We already have a focused portfolio of companies we understand
- We're already beating the dollar-cost-averaged S&P 500
- We'll avoid the typical start-up costs of buying a new holding
- We'll have fewer long-term tax and accounting concerns
- We'll have fewer incidental costs (stamps, checks, time spent) over the years
- We'll save time by not having to keep up with extra companies
- That time saved can be spent getting to know current holdings better
- All our funds are saved to invest in our current positions
- Extra risks ("diversified risks") are avoided
- Our risks are concentrated in just three holdings
- We may miss other opportunities
- We are less likely to continue learning about other industries
- We must depend on essentially three companies to carry us to our goal
If you have thoughts, please post them on the Drip Companies message board. Again, consider the question "Do we need to add more companies to the portfolio?" As you answer, provide your own pros and cons. We look forward to your Foolish thoughts here on the Drip Companies message board. Please title your post something to the effect of, "To Add or Not to Add."
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