Mellody's Math: With Financial Advisors, Less is More

The German architect Ludwig Mies van der Rohe once characterized his unique style of design with the simple, yet poignant statement, "Less is more."

Although he was referring to office and home design, I would argue the same can be said for building a stock portfolio.

Yet, my somewhat simple view appears to run counter to practices of a vast majority of today's portfolio managers, who seem to believe that when constructing a stock portfolio, there's safety in numbers.

With a portfolio potpourri, managers attempt to dampen the potentially negative effects of a lackluster performer or a languishing sector and thereby insulate themselves from being out of sync with the market.

Herein lies one of the biggest oxymorons of modern investing. While there has been an indisputable movement toward mitigating investment risk through the ownership of more and more securities, with these growing portfolios, professional fund managers are left to know less and less about their actual holdings.

In my view, this lack of in-depth, company-specific knowledge actually makes for riskier investing.

Don’t Scramble Your Eggs

So too believed Philip Fisher, an often-quoted investment sage who lived to tell tales of his experiences during the 1929 stock market crash.

In his book, Common Stocks and Uncommon Profits, he writes, "Investors have been misled, believing that putting their eggs in several baskets reduces risk. [Yet], the disadvantage of purchasing too many stocks is that it becomes impossible to watch all of the eggs in all of the different baskets."

The famed investor Warren Buffett offers his own critique of this popular phenomenon, calling diversification "a protection against ignorance." With his usual wit, he goes on to add that owning a little bit of everything is "a Noah's Ark way of investing [and] you end up with a zoo that way."

If Buffett is correct in his assertion that an investor's financial success is in direct proportion to the degree to which he understands any investment, then one has to wonder about the long-term prospects for a fund manager whose portfolio is comprised of hundreds of stocks.

In the execution of his own investment strategy, Buffett emphatically zeroes in on those few companies in which he has the greatest knowledge and confidence. He has often questioned "why an investor … elects to put money into a business that is his 20th favorite rather than simply adding money to his top choices — the businesses he understands best and that present the least risk, along with the greatest profit potential."

With this perspective, there have been times when Buffett has been known to place over 90 percent of his multibillion-dollar portfolio in the stock of just three companies.

Late Nights at the Library

Good portfolio managers are great researchers. Not only must they develop an intricate network when first considering an investment, in order to stay on top of a company's prospects, they must perpetuate a useful flow of information for the duration of their ownership of the stock.

This level of detail goes well beyond pure financial analysis. Managing a portfolio can be a daunting task. Replicating this process over and over again for dozens and dozens of securities would be a virtual impossibility.

  • 1
  • |
  • 2
Join the Discussion
blog comments powered by Disqus
You Might Also Like...