Overall the average return was 19.04%. I believe that is about 4 points better than the indices. The standard deviation is quite wide as you can see from the histogram above. Then I ran 10,000 simulations to see how 10, 20 and 30 stock portfolios would have fared. This is to illustrate the importance of picking 25-30 stocks in your portfolio unless you know what you're doing. If you have just 10 stocks, you run a much greater chance of under-preforming the indices.
| 10 Stocks | 20 Stocks | 30 Stocks | |
| Losing Money | 5% | 1% | 0% |
| Less than 10% | 24% | 15% | 9% |
| Less Than 19% | 47% | 48% | 49% |
| More than 19% | 53% | 52% | 51% |
| More than 25% | 30% | 23% | 20% |
| More than 30% | 18% | 10% | 6% |
| More than 35% | 10% | 4% | 2% |
So with just 10 stocks, you have a 24% chance of being under 10%, while the market was about 15%. But if you had 30 stocks, that risk lowers to 9%.
Have a great weekend everyone.
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2 comments:
Interesting distribution. I've been thinking about whether I should try and stick with the top 25 and strictly pick from that. I'm wondering that say there's 3 bad stocks out of the 25 that have a -25% return, but the overall top 25 gives you a 30% return, do you open yourself up to more risk if you pick from the top 100? Say there's 3 bad stocks per 25 so 12 out of the top 100. If you pick out of the top 100 you could conceivably although the odds would be low pick have all or most of those in your 25 portfolio. If however you stick to just the 25 you are more apt to get that tracking portfolio's return because you would be limited to the three bad stocks. By picking out of the 100 you could of course get 25 great stocks too so there would be increased upside. I'm wondering if the advice in the book to pick 5 at a time might not be as good as picking all at once. Because even though there are alot of stocks that stay the same in the top 25 there's enough variation where you could keep picking the bad 3 out of 25 every time you pick your 5 stocks. But if you do it all at once you are assured to match the tracking portfolio, which have been doing quite well. I think the magic formula works, I'm just trying to find the best way to mimick the returns and limit the possibility that while the formula is returning 30% I end up with -5%.
I think the advantage of picking 5 at a time, or however many at a time, just relatively even through the year, is somewhat akin to the theory of dollar cost averaging. Buy it all at once, and you run the risk of buying at the "top" of the market. Buy it evenly through the year and you have more likelihood of buying into occasional market dips or selling at market peaks.
Then again, I could be completely wrong.
-A
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