In previous episodes, the emphasis was on investing in well-diversified investment products when employing a Buy and Hold strategy. Does Buy and Hold also work with non-diversified assets, such as individual stocks or bonds?
All that and more in Episode 57 on the Wilson Wealth Management YouTube channel.
“What do you mean by ‘non-diversified’ assets?”
In this context, we are talking mainly about individual stocks and bonds. As well as other assets that may experience nonsystematic risk features and can be bought on an individual basis. A painting, home, stock option.
It could also include poorly-diversified or niche funds.
For example, a fund that invests solely in gold bullion may not be well-diversified. But investors tend to purchase gold as a niche investment to assist in diversifying the overall portfolio. So they are unconcerned about its lack of diversity.
Even broader stock or bond funds may not be well-diversified. Review the number of holdings in total, as well as the overall asset percentage of the top 10 holdings for too much concentration in limited holdings. Geography, capitalization and sector can also impact fund diversification. With bond funds, variables such as effective duration, credit quality, currency, geography, and issuer type can affect overall diversification.
But for these purposes, we will speak primarily about individual stocks and bonds, such as Coca-Cola or Google shares.
“Is it possible to build a well-diversified investment portfolio with individual assets?”
Yes.
However, you probably need a critical mass of investment capital to properly diversification.
Maybe you need 30-50 stocks. Some exposure to Canada. Also, the global markets. Do you want to diversify amongst small, medium, and large cap companies? Or through different industries and sectors? The more portfolio diversification you seek, the more holdings you need. And that requires capital to spread out your wealth.
Then, factor in additional asset classes such as fixed income. The number of portfolio holdings keeps growing.
So, yes, possible. Just takes time, energy, and capital. Much more effective and efficient to simply buy a ready-made fund.
I would note that most people create non-diversified portfolios. They hold 6-10 “fantastic” stocks and are fine in doing so. Perhaps they do well, perhaps not. If they invested in Amazon, Google, Apple, Facebook, Netflix, and Tesla, they will have done wonderfully versus the market.
The issue here is more what happens to the portfolio if Teslas begin to catch fire. Or the US and Australian governments crack down on Facebook. Or the EU hammers Google for its practices. Is there a company being created today that will cause Netflix to become the next Blockbuster? And so on.
That is the purpose of diversification. Spreading out the stock specific risk. And hedging your bets.
“How will my investment costs be impacted under this approach?”
The more investments you own, the greater the investment costs.
Not management fees to a fund company. But transaction fees when you buy and sell holdings. Perhaps tax when you sell and trigger a capital gain. Opportunity cost in spending time to monitor and maintain a portfolio with 30-50 stocks. Then add in bonds and any other asset classes and that is a fair amount of work.
“This will work well if I invest in highest-quality, ‘buy and forget’, holdings, right?”
Yes, you do want to invest in high-quality stocks and bonds.
But what is high-quality? An investment that is quality today, may not be quality tomorrow. And what is quality tomorrow, may not even exist today.
Not too long ago, companies like GM, GE, Kodak, Sears, etc., were household names and popular brands. With excellent stock. Today, they are all gone from their days of fame.
In their place, we now have Google, Tesla, Facebook, Netflix, etc. Companies that have really only been around for the last 20 or so years.
Kodak joined the Dow 30 in 1930 and departed in 2004. Before declaring bankruptcy in 2012.
Will Google, Amazon, Apple, Tesla, Nike, Netflix, and Facebook, all last that long? Or will there be new companies emerge that, as Apple did to Kodak and Netflix did to Blockbuster, knock off these high-quality companies?
Buy and Hold does not mean Buy and Forget. You need to monitor your portfolio and ensure it invests in quality holdings.
Diversified investment funds help achieve this. But when trading individual stocks and bonds, you need to constantly review and adjust your portfolio. This may results in hard costs (transaction fees, tax). It will definitely result in added time and energy to review your portfolio. If you have the free-time, interest, and knowledge, great. But for most investors working jobs in non-investment areas, sacrificing time to study investments becomes onerous.
Why not just stick to a well-diversified, low-cost fund instead?
For a little more on this topic, please read “Buy and Hold: Individual Assets”.
