I love music. But I can’t carry a tune, even if it was handed to me in a carrier bag. That doesn’t mean I can’t appreciate music, though. In fact, only last week I was fortunate enough to attend the Toyota Classics at Marina Bay Sands. What a performance! But what does The Covent Garden Soloists Orchestra have to do with investing? An orchestra, you see, is made up of various sections. It could include string, brass and percussion. When arranged in a considered way, they can make amazing music together. If not, a symphony could turn into a cacophony….
I love music. But I can’t carry a tune, even if it was handed to me in a carrier bag.
That doesn’t mean I can’t appreciate music, though. In fact, only last week I was fortunate enough to attend the Toyota Classics at Marina Bay Sands. What a performance!
But what does The Covent Garden Soloists Orchestra have to do with investing?
An orchestra, you see, is made up of various sections. It could include string, brass and percussion. When arranged in a considered way, they can make amazing music together. If not, a symphony could turn into a cacophony.
Surplus to requirements
If you watch the members of an orchestra closely, you might notice that not everyone is playing at the same time. But that doesn’t mean the ones that are not involved are surplus to requirements.
There are moments when the violas have to wait while the brass section blows their trumpets. Then there are times when the percussion players might have to sit on their hands whilst the violins fiddle away.
But every part of an orchestra has an important role to play, even if it is only a small part.
Something similar goes on in our investment portfolios.
The various shares that we own might not be performing at the same time. But paradoxically it might be better if they don’t, if we are to successfully ride the ups and downs of the market. If they all behaved in an identical way, then we could, worryingly, own too much of the same thing.
There are many theories that attempt to explain the benefits of diversification. However, I much prefer to use an egg. Why use intricate formulas when an egg would suffice?
The “eggs-planation” goes something like this: If you like omelettes then put all your eggs into one basket. Should you accidentally drop the basket then omelettes are probably about the only thing that the eggs could be good for. But if you prefer your eggs intact then consider putting them into different baskets.
In other words, if you spread your investments across a wide range of shares, then that could help minimise the risks that affect specific companies or industries.
The key is to buy stocks that are not correlated. For instance, a Real Estate Investment Trust such as CapitaMall Trust (SGX: C38U) and an Indonesian palm-oil producer First Resources (SGX: EB5) are unlikely to be related. So, what happens to one industry should not affect the other.
An often asked question is what should a perfectly-diversified portfolio look like? The answer is there probably isn’t one. However, a generally held view is that 12 to 15 unique stocks from different industries should provide us with enough diversification.
Building your 15-stock portfolio can be great fun because we can blend our choice of stocks according to our individual tastes.
Income investors might like more high-yielding stocks. Growth investors, on the other hand, might want to pack a few more fast-growing companies into their portfolios. Meanwhile, value investors could lean more towards a bigger array of undervalued shares. It might be a good idea to pop an index tracker into the mix too.
Having stocks of different attributes could produce a portfolio that is capable of delivering some income and some growth plus a hint of excitement, which never goes amiss.
The Warren Buffett moment
But what comes next is the really fun bit. I call it my “Warren Buffett” moment.
Buffett’s secret of success, surprisingly, is not stock picking. Instead it is the way that he uses capital. He once said: “The root of my success is acting rationally about capital allocation”.
The key is therefore to utilise the cash generated from your portfolio to shape its makeup over time so that it can grow and generate income repeatedly. I call my portfolio my “Perpetual Income Generator”.
Many of us might not be able to write music or play an instrument. But with a bit of thought and a sprinkling of patience, we can all make our portfolios sing beautifully.
A version of this article first appeared in Take Stock Singapore.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore Director David Kuo doesn’t own shares in any companies mentioned.