Latest / Stock Picking with Fexingo: Individual Equities, Research, and Building a Concentrated Portfolio / How to Build a Concentrated Portfolio in a Market at Records
Transcript
- Lucas: The S&P 500 closed today at 7,373. That's down about 1.3 percent from five days ago. The Nasdaq is off almost 3 percent. And Jeremy Grantham said this week that this is the most expensive market in American history. So the natural question — for anyone listening who owns stocks — is, what do you do with that information? Luna: And the instinct for a lot of people is to get defensive. Sell everything, go to cash, buy bonds. But you and I have talked before about how that's rarely the right move. Lucas: Right. And I think the more productive conversation is about concentration. If you're going to own stocks in a market at all-time highs with stretched valuations, the question isn't whether to be in or out. It's which stocks, and how many. Luna: So today we're talking about the concentrated portfolio. How many stocks should you own? When does diversification become diworsification? Lucas: Exactly. And I want to ground this in two specific stocks that are in the news right now. Berkshire Hathaway and Nvidia. Both are in the S&P 500. Both are huge positions in a lot of portfolios. But they could not be more different as pieces of a concentrated strategy. Luna: Let's start with Berkshire. It's up 1.2 percent in the last five days, while the market overall is down. That's the defensive quality people talk about. Lucas: Berkshire is essentially a concentrated portfolio in its own right. It's a single stock that owns dozens of businesses. But look at its top equity holding — Apple. Apple is down 6.1 percent in the last five days. Yet Berkshire itself is up. That tells you the insurance and energy and railroad businesses are providing ballast. Luna: So owning Berkshire is almost like owning a diversified fund, but with Warren Buffett's capital allocation on top. Lucas: Precisely. And then you have Nvidia. Down 6.9 percent in five days. It's the poster child for high conviction, high volatility, single-stock risk. If you had a portfolio of just Nvidia and Berkshire over the past week, you'd be down maybe 3 percent, depending on the weighting. That's not terrible. But if you were all-in on Nvidia? You'd be down nearly 7 percent in a week. Luna: And that's the risk people forget when they fall in love with a name. They think conviction means 100 percent allocation. Lucas: Right. So let's talk numbers. The academic research on diversification is pretty settled. By the time you own 15 to 20 stocks, you've eliminated most of the company-specific risk. But you still have full market risk. So a concentrated portfolio of 10 to 15 stocks, if you pick well, can outperform a broad index. But it also can underperform dramatically. Luna: And there's a behavioral angle too. When one of your 10 stocks drops 50 percent, that's a 5 percent hit to your total portfolio. That hurts, but it's survivable. When that happens in a 5-stock portfolio, it's a 10 percent hit. People panic and sell at the bottom. Lucas: Yeah, and that's the thing — concentrated portfolios require an iron stomach. You have to be willing to watch a single position swing 20, 30 percent in a quarter and not flinch. Most people can't do that. They say they can, but they can't. Luna: So who can? Who should even attempt a concentrated portfolio? Lucas: Honestly, someone who treats stock picking like a part-time job. You need to know the businesses you own inside out. Their competitive advantage, their capital allocation, their management. Not just the ticker. If you can't explain why your number one holding will be worth more in five years in two sentences, you don't know it well enough to concentrate. Luna: That's a high bar. But if today's conversation helped you think about your own portfolio a little differently, it might be worth a coffee. If it was, the link is buy me a coffee dot com slash fexingo. That's buy me a coffee dot com slash fexingo. And honestly, even if you just send it to a friend who needs to hear this, that helps too. Lucas: It does. And listener support is what keeps this show ad-free, so we really appreciate it. Now, back to the numbers. Grantham's point about this being the most expensive market ever — that's based on the cyclically adjusted price to earnings ratio, or CAPE. The CAPE is around 38 today. That's higher than 1929, higher than 2000. The only time it was higher was briefly in 2021. Luna: And yet, if you had sold in 2021 because valuations were high, you would have missed the entire 2023-2025 rally. Timing is impossible. Lucas: Exactly. So concentration is a middle path. You're not timing the market. You're just accepting that you can't own everything, and you're betting on your best ideas. But the key is sizing those bets appropriately. Luna: How do you think about position sizing? Is there a rule of thumb? Lucas: I like what the best investors do. They often size positions based on conviction, but cap any single position at 15 or 20 percent of the portfolio. And they rebalance when a winner gets too big. Charlie Munger famously said the first rule of compounding is never interrupt it unnecessarily. But he also had strict position limits at the Daily Journal. Luna: So it's not about having no rules. It's about having the right rules. Lucas: Exactly. And a good rule for the typical listener might be this: if you want to be concentrated, start with 15 to 20 stocks. See how you handle the volatility. Then if you're comfortable, you can go to 10 or 12. But I'd be very cautious about going below 10 unless you truly have an informational edge. Luna: And what about the argument that index funds are the only rational choice? Because we've had that episode — episode 58. Lucas: Right. And I think for most people, index funds are the answer. But there's a subset of investors who get real joy from picking stocks, who have the time and temperament, and who can add alpha. For them, concentrated active management makes sense. But they have to be honest with themselves about whether they have an edge. Luna: Let's bring it back to today's numbers. Berkshire is at 494.76. Nvidia at 194.20. If you had to pick one for a concentrated portfolio right now, which would you choose? Lucas: That's a tough one. I'd say Berkshire, because of its downside protection and the fact that it's already a diversified collection of businesses. But I wouldn't fault someone for Nvidia if they believe AI infrastructure spending is still in early innings. The key is, if you own Nvidia, you need to own something else that's defensive. Maybe Berkshire. Luna: So a two-stock portfolio of Berkshire and Nvidia? That's about as concentrated as it gets. Lucas: It is. And it's not for everyone. But for someone who understands both businesses deeply, and can stomach the volatility, it might work. The risk is that if AI demand disappoints, Nvidia could drop 50 percent. But Berkshire would likely hold up. The combined portfolio might only drop 15 percent. That's survivable. Luna: And survivable is the name of the game. Because if you sell at the bottom, you lock in the loss. Lucas: Exactly. So to wrap up — if you're thinking about building a concentrated portfolio, start small. Use 15 to 20 stocks. Know each business well. Size positions based on conviction but cap them. And be prepared to hold through drawdowns. That's how you compound over the long term. Luna: And if you want to learn more, we've linked to some resources on our website. But for today, I think the main takeaway is that concentration is a tool, not a strategy. Use it wisely. Lucas: Well said. That's it for this episode of Stock Picking with Fexingo. We'll be back tomorrow with another angle. Thanks for listening.