Best Ideas portfolio (with Josh and Michael)

Key takeaways

Diversification has proven to be a more reliable investment strategy over the long term, countering the notion that concentrated portfolios will always outperform.
Identifying a winning stock in the market is incredibly challenging, as only a small fraction of stocks tend to provide the highest returns.
Survivorship bias plays a significant role in how people view the effectiveness of concentrated investment strategies.
Investors may benefit from blending concentrated positions with broader index holdings to balance risk and opportunity.

Summary

The Dilemma of Concentration vs. Diversification

Josh Brown and Michael Batnick delve into the ongoing debate between concentrated portfolios and diversification. They discuss the conventional wisdom suggesting that holding fewer stocks may lead to better market performance. However, they highlight arguments from successful investors like Stanley Druckenmiller, who criticize diversification as misguided, advocating instead for focusing solely on high-conviction stock picks.

The Data Behind Portfolios: What Vanguard Found

A significant portion of the conversation focuses on Vanguard's research over the last 30 years, demonstrating that 47% of stocks were unprofitable. Importantly, only 7% of stocks yielded returns exceeding 1,000%, while 30% of stocks lost more than half their value. Josh and Michael emphasize the inherent difficulty in identifying these stellar stocks ahead of time and ponder the risks associated with concentrated investing.

Not All Concentrated Strategies Are Created Equal

While the allure of concentrated portfolios is discussed, the hosts question the efficacy of this approach. They cite statistical evidence indicating that larger, diversified portfolios statistically outperform smaller, focused ones over time. They also explore potential strategies for mitigating risks when trying to identify high-performing stocks out of the larger pool.

Survivorship Bias in Active Management

The conversation transitions into the pitfalls of survivorship bias, where only successful managers of concentrated portfolios are highlighted, while those who failed fall out of prominence. This discussion leads to a broader consideration of mixed strategies where a core concentrated portfolio could be balanced with indexed holdings, allowing for stability amid concentrated bets.

Show notes

In a recent study, Vanguard took a look at the last 30 years worth of data for the Russell 3000 index, which represents the total stock market. They found something remarkable - over the last 30 years, 47% of stocks were unprofitable investments and almost 30% lost more than half their value. They also found, and this is the big one, that 7% of stocks had cumulative returns over 1,000%.
But imagine how hard it would have been to identify that winning 7% and concentrate only on those holdings in advance? In his recent post, Michael Batnick takes Vanguard's data and looks at the long-term risk of trying to only hold a small amount of stocks, even if you have the conviction that they are the right stocks. Diversification has a much better track record than randomized collections of larger positions.
What are the ramifications of this for portfolio construction? How about investment advice? Michael and Downtown Josh Brown sort it all out in a brand new Live from the Compound.
Read Michael's post here and see the charts for yourself:
https://theirrelevantinvestor.com/2019/03/25/how-concentration-affects-portfolio-performance/
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