Absolute Focus

“Imagine the cost to us, if we had let a fear of unknowns cause us to defer or alter the deployment of capital.”
Warren Buffett, Berkshire Hathaway Annual Report 1994

Being a successful investor is all about patience, discipline, focus and conviction. How you measure your success is also very important. Most money managers and mutual funds have locked themselves into a relative measurement game. They better deliver returns relative to their chosen benchmark or else! The benchmark can be the S&P 500 index or the Russell 2000 index. This is exactly why these funds end up owning a large number of equities in their portfolios, sometimes in the 100s. You have to own the market to keep up with the market. This is also one reason why 90% of them end up underperforming the market. So if you want average returns, this is the path you should follow.

If you want above average returns, you must become a focus investor measured on absolute performance. Forget about the day to day and short term gyrations of the market and concentrate on the economic value of the businesses you invest in. As we have discussed in the past, holding a large number of stocks in your portfolio doesn’t reduce the risk, it just spreads the risk. You are better off building a focused portfolio which enables you to become intimately familiar with each business you own. Don’t forget, you are part owner of a business when you buy stock, even if it’s just a 100 shares.

How many holdings should a focused portfolio have? Well, Warren Buffett has said he would not consider making an investment unless he is convinced he would want to commit at least 10% of his net worth. This implies a portfolio of 10 holdings. His partner, Charlie Munger, who had started his own partnership in the 1960’s had concluded that owning as few as 3 stocks would provide him with above average returns. And he was right. From 1962 to 1975, his partnership returned an average of 24.3% annually vs. the market's 6.4% return. The one caveat was that he achieved this by enduring increased volatility. The portfolio significantly underperformed the market in some years.

Indeed, a focused portfolio is not for the faint of heart. You must have the temperament and psychological wherewithal to stand the peaks and valleys. You must be patient, avoid the temptation to buy and sell and ignore market forecasts. After all, wars and market crashes and oil shocks did nothing to deter Warren Buffett from staying the course. You may underperform the market from time to time, but in the long run you should handily meet or exceed an absolute measure of performance such as inflation plus 10%.