Fisher Investments’ Founder, Ken Fisher, Debunkery: Concentrate to Build Wealth

Transcript

Ken Fisher:

Always own stuff that you think will do well. Spread across all kinds of stuff in not too big of sizes. But also own some stuff that you think will do badly. Except, you say "think will do badly?" Why would I want to own something I think would do badly?

Each month I take a one of the many short chapters, a couple page chapters out of my Debunkery book to debunk some common concept. And this month I'm going to talk about concentration portfolios. Now everybody's heard lines that are like, don't put all your eggs in one basket, never own more than x percent of your portfolio in one stock. You get rich by concentrating your portfolio, but you can also go broke by concentrating your portfolio.

These are all broad statements that have some truth and some distruth to them. But there's a couple of things we can say. Generally, concentrating your portfolio is a high risk, high return activity because generally you never really know that much about these companies to be sure about what will happen if you had, I'm making this up, eight stocks in your portfolio, You could potentially make a lot of money. You could potentially lose a lot of money or anything in between. So it increases the risk that you don't get to where you need to go to.

For the potential opportunity of hitting big at the risk of going home. And you know that intuitively. On the other hand, you hear people and correctly say that you can way over diversify and many people do. In fact, usually over diversification also does not accomplish the goal of diversification, which is to reduce risk, but becomes a more complicated portfolio where you don't actually see a lot of the hidden risks in all of the different things that you own. And risk in a way gets out of control.

I want to talk about a couple of variants of this that are in the book that people don't think through. One way that people make a mistake all the time is say, "yeah, but I'm investing in the company that I work for, I know it. I've been there for eight years, and I know this company really well." Yeah, maybe. But you don't control the company.

And the fact of the matter is, all kind of people in life have done that and had the exact same experience of hit big or go home. The most famous examples of that have been the ones where companies have actually imploded out of nowhere, like Enron did almost a quarter century ago through fraud. But the fact of the matter is that simply, you think you know it, but stuff happens. Now where that changes and I turn that on his head is, let's say you're the CEO. Or maybe the president, chief operating officer, or maybe the chief financial officer right at the very top. Then you actually have powers, particularly if you're the CEO, that are effectively like control. And then maybe concentrating is perfectly okay. And in fact, an awful lot of the people in the world have become the very richest got there exactly that way.

Running a company, being invested in the company and controlling the company. Because control is different than I think I know. Because when I think I know, but I don't control he or she who controls can actually screw it up. And it doesn't take that long and it doesn't need to go bankrupt like Enron did. It could just lose most of its value and hurt you. But also you can extend that concept a little bit. Instead of being the CEO or the chief operating officer or the CFO chief Financial officer.

You could think about it a slightly different way. In my Ten Roads to Riches book, I talked about what I call ride alongs. An archetypal example of a ride along that I cited then was legendary. Charlie Munger recently passed away. Great guy who was a ride along to Warren Buffett. Number two, supportive always. Buffett got the big ego strokes. Munger was always Mr. Support. Munger had different ideas, counterbalanced Buffett's views. They worked well together, and while he didn't become as wealthy as Warren Buffett, he certainly became a very prosperous billionaire by riding along in that position right next to control. Again, a perfect place to concentrate.

But off on the other side of the coin you want to think about what portfolio theory is supposed to be about. What portfolio theory is supposed to be about is true diversification, and what true diversification is all about is not, oh, I'm going to own 100 stocks or 50 stocks or some specified number of stocks. It does include don't own too much in any one stock. But it's this part that Harry Markowitz in 1951, shortly after I'd been born, laid out as the right way to think about portfolio construction, which is rarely implemented correctly, but can be. Which is, always own stuff that you think will do well.

Spread across all kinds of stuff in not too big of sizes, but also own some stuff that you think will do badly. Except you say "think what do badly? Why would I want to own something I think would do badly?" You want to own things you think will do badly, but if and only if, if the things you do think will do really well. End up not doing well, and the features that would cause them to not do well will make those who expect to do badly do really well. That makes a portfolio that's locked together. And zigs and zags more gently, relative to the turbulence in the real world.

Because they co-vary the parts co-vary against each other. If your portfolio is mostly the things you think you do really well and you're right, you're going to do just fine. And those other laggards bring down your return a little, but not that much. And yet, on the other hand, if those things you think will do well do really badly, but it set up so that these will be the ones that do really well if those things do really badly.

You never get really killed, relative to the market. And that's an important structure in terms of diversification and an important way to think about what's the right amount of concentration. You can do that with two, three, four, five percent positions across your portfolio. That dominates the number of stocks you have. And think of how they move against each other, not just what you think about whether they'll do well or badly. Thank you very much for listening to me.

Voice of Ken Fisher:

I very much hope you enjoyed this video as part of my series on debunking Common Market Myths. To watch more videos like this, click the link on the screen and make sure to subscribe to Fisher Investment's YouTube channel. Thanks so much for listening to me.