February 15, 2006

Portfolio size matters!

The above may sound strange. Ofcourse, warren buffett has famously said that large amounts of capital act as an anchor on investment results, but then it is more so for the professional investor and certainly not for individual investors like us.

But I have different viewpoint and it goes like this. For me investing is more of risk than return. Before I look at the likely returns, I tend to look at what I could lose under the worst case scenario. Now the worst case scenario for an individual stock is ofcourse 100%. But it likely that during a market downturn, the portfolio can drop by 25% or more (even for a conservative investor)

It is under these conditions that the portfolio size becomes important. How much is the portfolio as a % of your networth? If it is 20-25 %, I can rationally handle a loss of upto 50%. But if the portfolio is 100% of my networth, I think I would not be rational if the portfolio drops by 50% or more. I could very likely panic and sell at the bottom. Now you may feel that you would not react in that fashion and it is quite likely. But believe me, if you are one of those who started investing seriously in 1998-99 and saw your portfolio go down right upto 2003, you would have wondered when it would end.

Ofcourse looking back at 2003 now, feels like april/ may 2003 (the lowest point of the indian market) was a wonderful time to start investing as the great bull market was ahead of you. But if history was any guide at that time, the market has gone nowhere in the last 10+ years and one had to have the conviction to hold onto and better add to your portfolio at that time (with a negative performance to boot!). It is precisely for this reason that I am conservative in my approach and once I have a few years of experience and have gone through atleast one bear and bull market will I increase my equity portfolio as % of my networth.

So next time when you hear some one brag that he had fanatastic return last year on his portfolio, ask him what % of his networth has he put into equity and has he gone through a bear market with that percentage. If he/she has a high % of networth in the stock market, has had a fanatastic run in the last 2-3 years and is feeling that he/she is the next warren buffett, smile and better, pray for him that he pulls out before the next bear market.

So what if one is levearged and has more than 100% in the market and has seen only the bull market. Unfortunately these are the people who hit the headlines when the market tanks.

4 comments:

abhi said...

I share a similar experience when I started investing in US stock market in 99 and saw everything I owned lost significant value. I think it make you wonder if you did all your research and picked the right companies why you lost.
This led me to start studying successful investors and financial stock market history. It has definitely made me more conservative and better investor.
I think for most of people out there they need to go through a bear market to understand what makes bull market and what make it a bear market again.
The most important lesson I learned was the price you pay determines your return. It just resonated with me. This holds true for me in every scenario unless in a scenario where I can predict things better.

abhijeet said...

O.k having read your blog i get a feeling that markets can be bullish or bearish.But i do not understand what makes these markets bullish or bearish,is it a lottery phenomenon????i really do not understand what causes the commodities like tea and sugar to rise on a particular day or rather days and then suddenly backtrack,everything is manipulated and i think in hands of some big harshad's and ketan's.Recently there was the news that some dalmia has been caught who was a colleague and a close friend of Ketan parikh.I think people like these should be given death sentences and the life of such people should be put to end in the public and that to in a brutal way.....we salaried people earn our money working hard day in and day out...then invest some portion of it in equities and suddenly see all our money has been lost...i bought kanakdhara steels on prescription by so many investment houses......i poured my one complete years salary into it to finally see that the name is missing from the stocks being traded on the BSE.....but as they say a drunkard cannot become a teetotaler and so i too cant leave investing but this time in companies like reliance and tata's which i hope cannot run away:)

Shankar said...

Hi Abhijeet,

This is a pertinent question - why does the stock market go bullish and bearish? Let's take it one step below .. why does an individual stock go up and down, every single day? You should read about Mr. Market for more answers - read pg 18-19 of the document (
www.econ.duke.edu/Journals/DJE/dje2000/bierig.PDF)

That should make things clear for you

Warm regards
Shankar

ValueArchitects said...

good post!!