The Skeptical Investor by John Lawrence Reynolds

Author:John Lawrence Reynolds [John Lawrence Reynolds]
Language: eng
Format: epub
ISBN: 9780670064052
Publisher: PENGUIN GROUP (CANADA)

Should You Assemble a Portfolio of Individual Stocks?

Well, Yes and No …

Some Canadian investors are so jaded by mutual fund performance that they are seriously considering what was once unthinkable: bypassing mutual funds entirely and building a basket of stocks on their own. Is this a good idea?

The problem is diversification, which, along with quality fixed income elements such as guaranteed bonds and laddered GICs, represents a bulwark against overwhelming loss. But how many stocks does it take to minimize portfolio loss? Some people claim 15 or 20. Many believe it takes 40. Others, such as investment guru and author William Bernstein, snort at the very idea of fewer than 500.

In a published study titled The 15-Stock Diversification Myth, Bernstein claims that over 28 years, from 1980 to 2008, all of the gains reported on the NYSE and NASDAQ were recorded by the top 25 stocks; the remaining 75 percent recorded losses. On that basis, the odds are 3 to 1 against success should you choose a portfolio by throwing darts at the complete stock listing.

You wouldn’t do that, of course. You would carefully ponder the future of specific industries, examine past performance of selected companies, weigh this against future prospects, and make your decisions in a methodical manner.

Very nice. But how would you identify companies that Bernstein calls “Super Stocks,” names such as RIM or Potash or Dell or Walmart, companies that achieve massive gains, propelling their indices to extraordinary heights well beyond any expectation? You likely wouldn’t.

Bernstein focused his attention on the U.S. stock market, about 30 times bigger than the Canadian stock market in total assets, so the universe is considerably smaller in this country. While his theory applies to a similar degree to Canada, it should be subject to modification.

Consider technology, for example. Bernstein mentions Dell as a Super Stock, and it clearly qualifies. He could also have mentioned, in their earlier incarnations at least, Microsoft, Cisco, Sun, Oracle, HP, and at least a dozen other large-cap technology-based companies that qualify. In Canada we have one: RIM.

Here’s another difference: No one of consequence is promoting the idea of investing in U.S. financial organizations in 2010, except on a speculative basis. Canadian banks, however, represent a buttress of stability with reasonable prospects of growth and an impressive record of dividend payments. But no Canadian bank can deliver Super Stock performance to the degree that Citibank may or may not. Royal, TD, Scotiabank, and the rest are attractive at least as much for their dividend records and stability as for their growth prospects. Let’s face it— assembling a portfolio of stocks in this country means opting for the dull and steady over the wild and risky. Hey, isn’t that the Canadian Way?

So consider this strategy: Choose broadly based ETFs as a foundation of your equities spiced with selected individual stocks. Annually, or whenever you achieve a targeted gain in the sector stocks—say 50 percent—plan to rebalance the sector. Reaching a targeted gain of 50 percent might trigger selling

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