The Dangers of Concentrated Portfolios: Why Diversification Matters

A recent survey of Germans has highlighted a concerning trend: most investors hold far too few stocks in their portfolios, with 56% of stock investors holding fewer than five. This lack of diversification can lead to portfolios being exposed to significant volatility, as illustrated by the Canadian Free Cash portfolio. This portfolio, which invests in 10 Canadian stocks with the lowest enterprise value to free cash flow ratios, has achieved an average annual return of 15.9% over 25 years, significantly outperforming the S&P/TSX Composite Index. However, a single-stock variant of the portfolio was three times as volatile as the 10-stock version and suffered a 78% decline in 2017.

Key Takeaways:

• A recent survey of Germans found that 56% of stock investors held fewer than five stocks in their portfolios, highlighting the need for diversification.
• The Canadian Free Cash portfolio, which invests in 10 Canadian stocks, has achieved an average annual return of 15.9% over 25 years, outperforming the S&P/TSX Composite Index.
• A single-stock variant of the portfolio was three times as volatile as the 10-stock version and suffered a 78% decline in 2017.
• The portfolio selects its stocks by starting with the largest 300 companies on the Toronto Stock Exchange by market capitalization, then buys the 10 with the lowest, positive, enterprise value to free cash flow ratios (EV/FCF).
• The Canadian Free Cash portfolio demonstrates the importance of diversification in minimizing portfolio risk and maximizing returns.

Statistics:

• 56% of stock investors in a recent survey held fewer than five stocks in their portfolios.
• The Canadian Free Cash portfolio achieved an average annual return of 15.9% over 25 years.