But first, indulge me.
>How much of your wealth is invested in direct stocks?
>How many stocks do you own in your portfolio?
>How much do you allocate to each stock?
>What’s your win rate with stocks?
Generally speaking, you would hold about 10% of your wealth directly in stocks, other than mutual funds but including real estate. Go on, put the numbers in an excel sheet and check! You probably own about 20 stocks. You do not follow an ‘asset allocation strategy’. You often double down when a stock falls, by buying more of it. And your win rate is probably 30%. Yes, you need to also add up all those loss-making bets you had to exit.
Now, generally speaking again, I would say the correct answers to the four questions above would be:
>You should have about 30% to 40% of your wealth in stocks.
>You should own no more than 8 to 10 stocks.
>You should allocate at least 10% (of your stock portfolio), if not more, to each stock to begin with.
>You should aim for a win rate of at least 70%.
If you’ve read this far, you probably strongly disagree with at least three of the four answers. So, let’s take them one by one.
Thirty per cent of your wealth in stocks is generally a fair allocation. It is more than you believed you had allocated, and far less than what some gurus tell Mint (90%). Why fair? Well, there are no guarantees in life. And it’s especially true of stocks. On the other hand, you want to be absolutely sure you do not miss the India opportunity staring us in the face. So, you need to allocate the maximum possible to lift your overall returns. At the same time, ensure you have not put all your money in one asset class. About the gurus allocating 90% to stocks, well, that’s for another piece. Wait for that.
Now, to the 8-10 stocks part. This is probably something no one agrees with. My counter to that is: if you really plan on investing in 20 or 25 or 30 stocks, why don’t you just opt for a professional fund manager instead? Or an index fund? Fund managers have teams of people studying stocks all the time to manage their portfolio. Can you do it alone? Maybe. Can you do it better than a professional? That’s something to think about. At the same time, if you are smart enough to spot a handful of opportunities in the market, then why not make a big bet?
Like Warren Buffett famously said:
The trick in investing is just to sit there and watch pitch after pitch go by and wait for the one right in your sweet spot. And if people are yelling, ‘Swing, you bum!’, ignore them.
Keep waiting for the right opportunity, and when you find it, swing for the fence. Now, there are many ifs and buts here, the most critical of which is: Do you have the skill to research a stock? If you do not, then investing in stocks directly is not for you. But if you do, then you need to double down on this skill.
Let me take two scenarios and crunch some numbers here to drive this home.
Scenario 1: Assume an investible corpus of ₹1 crore, of which you invest 10% or ₹10 lakh in stocks, believe in the invest-in-30-stocks approach, with average allocation of 3% per stock. Here’s the math, for a stock like Tata-elxsi-share-price-nse-bse-S0003158″ class=”autobacklink-topic” target=”_blank” rel = “nofollow” data-name=”Tata Elxsi” >Tata Elxsi before its 10x rise. Your allocation to that was, naturally, 3%.
> ₹30,000 allocation to Tata Elxsi became ₹3 lakh.
> ₹10 lakh portfolio became ₹12.7 lakh, assuming all else remains the same.
How did your overall wealth change? Since you have 10% of your wealth in stocks, a 10x return changed your overall wealth by about 2.7%. No more, no less. So much excitement. So little impact.
Scenario 2: Now imagine, you invest 40% of your ₹1 crore basket into stocks, which is ₹40 lakh, believe in the 8-10-stocks-approach, and have an allocation of 15% per stock (about ₹6 lakh or a little more).
>10x on Tata Elxsi will turn the ₹6 lakh into ₹60 lakh
>And the ₹40 lakh portfolio into ₹94 lakh
That’s a profit of ₹54 lakh, and an overall gain in wealth by 54%. Impressive, right? I know this is easier said than done. But then, that’s why it’s said investing is “simple, but not easy”. Can you pull this off? Well, Vijay Kedia did. He is all about making big bets. It takes a lot to get there. The right stock research, the right valuation to get in, and then the mental framework to be able to deal with what comes next.
Like I said, easier said than done. Perhaps listen to my podcast with Vijay on YouTube. It’s a master class on making big bets. Now, before someone tweets me to say that Vijay owns more than eight stocks, well, that’s true, but the point is he got rich making several big bets. Now that he is very big, he can afford to spray his money over a wider range of stocks.
Let’s get back to the 10% allocation bit. Sometimes, you like a stock, even start to buy it, but then the stock really runs away. You are stuck, your allocation is not filled in. What do you do in such a situation? Well, if it’s a very small allocation, the question to ask is whether it’s really worth your time. As you saw in Scenario 1, a 3% allocation won’t do you much good, but it will still take resources. So, you’ve got to set some hard rules here.
There could be other scenarios too when you do not meet your 10% criteria. For instance, if the stock sells off. Should you sell out, or perhaps buy more? All these are important questions and require you to revisit your investment thesis all over again.
Finally, the win rate of 70% is a low bar. You need to aim even higher. I know the following Buffett quote is overused, but only because it’s absolutely essential to remember at all times:
Rule No. 1 – Never lose money
Rule No. 2 – Never forget rule no. 1
Money lost is not just money lost. It’s also an opportunity loss. So, it’s kind of a double whammy. When investing in stocks, aim high. If you have it in you to get there, you are fine. If not, maybe it’s time to reconsider whether you are better off with a professional fund manager or an index fund.
In conclusion, I must confess that I have relied on generalisations to make my points here. But this is what I see around me. I rarely see people’s lives change because of how well they invested in stocks, even though they keep talking only of their winners. It’s an enigma that continues to confound me.
Again, in general and, if and only if, you can establish you are really good at picking stocks: allocate more of your wealth to stocks, wait for the right stocks and allocate significantly to each stock and, finally, work very hard to not lose money.
Rahul Goel is former CEO of Equitymaster. You can tweet him @rahulgoel477.
You should always consult your personal investment advisor/wealth manager before making any decisions.
