If I told you I would hand you some money to buy a few shares of a stock, but only if you could tell me which company was at the top of your buy list, could you do it? Most investors probably could do no more than toss out a random name, because few keep an up-to-date shortlist of their best investing ideas.
Yet such a list is crucial -- even beyond the obvious reason of knowing which stocks to buy when opportunities arise. The very act of diligently keeping such a list will sharpen your investing skills. It forces you to develop a thesis for every company, and to constantly reassess that business to make sure your thesis still holds. You'll also be in better tune with valuation, especially relative to other companies in the industry.
My own portfolio includes full positions in some stable, blue-chip stalwarts such as Procter & Gamble
So when it came time to add new money several months ago, I felt I had good balance in the portfolio, and I was free to consider almost any stock. For many reasons, including solid management, reliable cash flows, and compelling valuation, Johnson & Johnson
Of course, only time will tell whether that was a good buy. But because I keep an up-to-date list of my best stock ideas, I was able to buy with confidence when the opportunity presented itself.
Look inward, grasshopper
When making your list, don't forget stocks you already own. All of us will have a limited number of great ideas in our investing lifetime. Often, your best stocks are already sitting in your portfolio, just waiting for new money.
Most of history's greatest investors followed this route. You may already be familiar with Charlie Munger's disdain for overdiversification; he'd rather have his money in a small handful of stocks, allocating not a single penny to any second-tier idea. David and Tom Gardner are thinking along the same lines for their Motley Fool Stock Advisor members. Each month, they publish their top five stocks to buy now, for those ready to allocate new money.
That said, don't think that you need to limit yourself to just four or five stocks. In fact, the less experienced you are as an investor, the more diversity you need in your portfolio, to keep one or two bad mistakes from torpedoing your net worth. Masters like Munger and Buffett are tops in their field; they're not perfect, but it's highly unlikely any one investment of theirs will completely tank and significantly harm Berkshire Hathaway shareholders. The rest of us, however, need a bit more diversification.
But no matter your investing experience, you'll want to focus on your best ideas as you add new money. And as the years roll by, if you were right about most of your ideas, the extra concentration in them will supercharge your returns.
The short story
Do you need help compiling your own short list? The most important consideration, especially for the average individual investor, is balance: between large and small caps, between less risk and more risk, and among different industries. As any chart will show, if you owned ExxonMobil five years ago, buying another oil giant like Chevron
And don't be afraid to seek out qualified help. As I mentioned, David and Tom now publish their own short lists in Stock Advisor; each list contains their five best stock picks for new money now. They happen to be pretty good at what they do, with 70% average total returns for their recommendations since the service began more than four years ago, vs. 34% for equal amounts invested in the S&P 500.
It won't cost you a dime to see their lists and all their recommendations. If you're interested, click here for more information on a 30-day free trial.
This article was originally published June 10, 2006. It has been updated.
Rex Moore parks in a driveway and drives on a parkway. He owns shares of all companies mentioned in this article except ExxonMobil and Chevron. Anheuser-Busch and Berkshire Hathaway are Motley Fool Inside Value recommendations. Ctrip.com and Buffalo Wild Wings are Hidden Gems recommendations. Johnson & Johnson is an Income Investor recommendation. This information is brought to you by the Fool's disclosure policy.