Way Back in 1971
It has now been over four decades since I first developed what today is our Retirement Compounders strategy. In the sixties, I researched diligently on portfolio diversification and how few stocks it takes to replicate the diversification of the entire stock market. I took what I learned about portfolio construction and tied in my theory that concentration on dividends and the power of compound interest should control portfolio construction.
Dividends Then and Now Are the Answer
While at Babson College, I studied Ben Graham’s Security Analysis. I still return to it regularly. In Chapter 35, Ben Graham writes,
“For the vast majority of common stocks, the dividend record and prospects have always been the most important factor controlling investment quality and value…. In the majority of cases, the price of common stocks has been influenced more markedly by the dividend rate than by the reported earnings. In other words, distributed earnings have had a greater weight in determining market prices than have retained and reinvested earnings.”
Graham concludes with,
“Since the market value in most cases has depended primarily upon the dividend rate, the latter could be held responsible for nearly all the gains ultimately realized by investors.”
Always Keep It Simple
Made sense to me in the sixties and continues to make sense to me today. In fact, I attribute most of the success I have had in the investment industry to what I learned from Ben Graham nearly five decades ago. To keep track of dividends today, I rely on the same S&P Stock Guide that I relied upon when I began in business. Keep it simple and good things happen every time.
Back to the Future
Back in 1971, I regularly reviewed my ideas with an investment industry buddy. Dave Hammer, a quantitative guy, had his own model for portfolio success. We both concentrated directly on the concept of the power of a limited number of portfolio securities.
An individual investor is certainly willing to hold two stocks rather than a single stock. Diversification doubles. How about again doubling diversification by moving to a four-stock portfolio? No problem. Another doubling and you are at eight stocks, still comfortable for the individual. Next up are 16, 32, 64 and 128. What do you think? As far back as the 1970s, Dave and I wanted no part of 128, even for institutions, and we both thought that 64 was perhaps a troubling number. So we settled on 32 stocks as a theoretical outer limit for even the professional investor.
Wicked Stock Market Volatility
All these decades later, I am still fine with 32 stocks for the individual investor. But for the professional investor handling sizable investment accounts, the technology landscape has shifted enough that I now feel comfortable with a 64-stock portfolio.
Because of the wicked volatility in today’s computer-driven markets, I feel that it is now appropriate for our family management company to judiciously add names with a downside limit of the same 32 stocks, as always, but an upside limit of 64 stocks. With complete disclosure in mind, we do not have anything like 64 stocks that we would want to buy today for our RCs, but we will pick away one by one as yields dictate.