The psychology of investing is often the most challenging part of portfolio management, particularly during reporting season when there is significant volatility, and/or one stock may disappoint.
However, it needn’t be if an investor approaches the task of portfolio management with the right mindset and understands irrespective of whether the investment objective is growth or income, the main game needs to be an unwavering focus on the total portfolio achieving its end goal.
A portfolio is an eco-system of stocks that should be selected to help the investor minimise portfolio risk (i.e. the likelihood that the portfolio will not achieve the investor’s objective). While it is crucial that stocks are selected to give you the best chance of meeting your long-term goals, being fixated on the individual short-term performance of a specific stock yields little return and often delivers an inequitable amount of stress and anxiety relative to the role it plays.
Keeping things in perspective
Let’s face it, in a well-diversified portfolio, the performance of one of your holdings should not have a disproportionate impact on the total return you receive. To explain this concept, let’s take a notional portfolio of $100,000 and an equally spread $5,000 over each of 20 great businesses aligned to your objective.
The following day, 19 stocks retain their value, however, one stock falls 40%. Typically, such a significant fall would cause acute stress, particularly in light of the stable performance of the other companies. However, calmer heads will tell you that such a fall relative to the overall portfolio is small. In fact, a 40% fall in one stock in a portfolio of 20 stocks, where the others have held their value, is only a 2% fall in the total value of the portfolio. Putting this in a more palatable light, experienced investors will tell you that a 2% swing either positively or negatively in the value of your total portfolio can be an almost weekly occurrence.
Focus on what is important
The reality highlighted above has a much broader application than merely ignoring short-term movements in price. Often, a savage decline in a stock is accompanied by a change in the fundamental position or outlook of the business. Many investors fall into the trap of holding onto the stock in the hope that recover all its lost territory. Again, experienced investors will tell you this rarely occurs, and if it does, it is usually a very drawn out process that can take months or years (in many cases never).
To be successful in the long run; we must ignore past performance, either good or bad, of a single stock, and think about the future of the portfolio as a collective and make decisions in its best interest. We often forget that in the share market we have a choice of where to allocate our money daily to maximise future returns. A decision to do nothing with a stock is still a decision and continuing to allocate your money to an underperformer will not change the likely outcome. It, in fact, entrenches your portfolio into perennial underperformance.
As investors of our life savings we are obligated to ensure that we are holding a spread of 15 to 20 great business in our portfolios which as a collective give us the best chance of meeting our desired objective and managing our stocks proactively. Focusing on negative performers can distract us from making the decisions we need to make for the collective benefit.
To use the analogy of a football team; when your portfolio eventually wins the Grand Final, no one remembers the player that was dropped in Round 14 and never played that season again. However, rather than being defiled, they are remembered fondly as part of the journey that eventually saw the entire team achieve ultimate success. Considering the removal of stock in such a good light may go some way to making it easier for investors to make decisions when they need to be made and to focus on the total portfolio’s end goal. Had the decision been made to persevere with the player for the remainder of the season, would the outcome have been the same? The reality is no one will care when they are all singing the team’s anthem at the end of the match!
Published 30 August 2018
www.afr.com | Financial Review
Important : Lincoln Indicators Pty Limited (Lincoln) ABN 23 006 715 573, as Corporate Authorised Representative of Lincoln Financial Group Pty Ltd ABN 70 609 751 966, AFSL 483167. This communication may contain general financial product advice. Our advice has been prepared without taking account of your personal circumstances. You should therefore consider its appropriateness, in light of your objectives, financial situation and needs, before acting on it. Before acting on any advice, you should consider the appropriateness of the advice and we recommend you obtain financial, legal and taxation advice before making a decision. Please refer to our Financial Services Guide (FSG) for more information at www.lincolnindicators.com.au
If our advice relates to the acquisition or possible acquisition of a particular financial product, you should obtain a copy of and consider the Product Disclosure Statement (PDS) at www.lincolnindicators.com.au before making any decision.
Lincoln, Lincoln Financial Group Pty Ltd and directors, employees and/or associates of these entities may hold interests in these ASX listed companies. This position is disclosed within the Stock Doctor program and may change at any time without notice.
© 2018 Lincoln Indicators Pty Ltd. All rights reserved.