Course 501: Constructing a Portfolio
The Fat-Pitch Approach
In this course
1 Introduction
2 The Fat-Pitch Approach
3 What Do the Academics Say?
4 How Many Stocks Diversify Unsystematic Risk?
5 Non-Market Risk and a Concentrated Portfolio
6 Portfolio Weighting
7 Portfolio Turnover
8 Circle of Competence and Sector Concentration
9 Adding Mutual Funds to a Stock Portfolio
10 The Bottom Line

In Lesson 405, we introduced you to the concept of the fat-pitch approach. We noted that you should hold relatively few great companies, purchased at a large margin of safety, and that you shouldn't be afraid to hold cash when you can't find good stocks to buy. But why?

The more stocks you hold, the lower your chances of underperforming the market. Of course, the more stocks you hold, the lower your chances of outperforming the market, but your portfolio is less risky. So the key question to ask yourself is: "Why do I invest in individual stocks at all?"

If the answer is that you think you can do better than a mutual fund, then you should hold a fairly concentrated portfolio of stocks because that gives you the highest odds of outperforming the averages. By "fairly concentrated," we mean 12 to 20 stocks.

As we previously noted, most investors will discover only a few good ideas in any given year--maybe five or six, sometimes a few more. Investors who hold more than 20 stocks at a time are often buying shares of companies they don't know much about, and then diversifying away the risk by holding lots of different names. It's tough to stray very far from the average return when you hold that many stocks, unless you have wacky weightings like 10% of your portfolio in one stock and 2% in each of the other 45.

Next: What Do the Academics Say? >>


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