Managing a diversified portfolio

There’s a regular topic of conversation in investing circles around diversification and how many stocks an investor should own to be sufficiently ‘diversified’. The general consensus seems to be that diversification runs on a spectrum of portfolios with 10 or less stocks being super concentrated ‘high risk, high return’ and 40 or more being ‘deworsified index trackers’, with the optimal level being somewhere around 30 companies.

At the moment, I hold just under 30 listed companies and 4 investment trust/collective investment vehicles. I manage these through the following process;

Monthly Review

Financial information for a portfolio doesn’t change ‘wholesale’ but is more of a gradual process. I set a date once a month to undertake a ‘portfolio review’ where I check each company’s finances and progress, and make a decision to buy, hold or sell. Don’t ‘ignore’ a bad trend and don’t ‘pretend’ to have made a decision by doing nothing. If you want to hold, make it a conscious decision – don’t just do it by default of taking no other action.

  1. Check for quality. If I’ve already made the decision to buy this company then I want to see them growing revenues and profits, reducing debt (if they have any), and hopefully increasing their dividends. I generally look to see this trend over 2-3 years as a minimum – if a company falters, then it’s not an automatic ‘sell’ signal.
  2. Check for value. Just because a company was good value when I bought it, it doesn’t mean it still is now. If a company quadruples it’s share price in 6 months without quadrupling revenues and profits, it’s P/E value will shoot through the roof. I’m averse to holding companies on a p/e of more than 20 (not an absolute rule, but a guide) and anything with a yield lower than 2%.
  3. Compare against other options. What else do I hold that might be a better investment? Is there anything in the market that I’m watching and want to move into?

On-going research

I register to receive company updates directly as soon as I invest. The first thing I do in the morning is to review any news, financial forecasts or trading updates on the way to the office. This supports my understanding of my investments and helps me to evaluate if any of my companies should be sold or added to. Sadly, some company updates are a little less understandable than others but I always persevere and keep going over them until I’m sure I understand what is being said.

I also have a ‘watchlist’ of companies I’m considering investing in and like to really understand them in-depth before making a decision. I want to understand the following issues to determine if they paint a positive picture. If they don’t, I’ll immediately reject the company – no point wasting time thinking about sub-optimal companies.

  1. What they do
  2. How they make money
  3. How they use debt
  4. Their valuation
  5. Any potential risks
  6. Trading history
  7. Brand perception
  8. Leadership team credibility

Both of these steps require something I fear a lot of amateur investors shy away from because they’re hard work. It’s much more fun to watch a film, play a video game, or go for a pint than spend a few hours a week pouring over trading updates and this is one of the key reasons I feel so comfortable ‘holding’ through market volatility.

By building a really detailed understanding of your companies, their strategy and most importantly their financial resilience, it’s far, far easier to hold through temporary market panics and routs.