Opportunities for big bets come seldom; Focused Investing is a sound strategy to capitalize on them.
f = (bp – q) ÷ b
where:
f is the fraction of the current bankroll to wager, b is the net odds (expressed as rupees to be won for every rupee bet) or win-loss ratio, p is the probability of winning, and q is the probability of losing.
The above formula was developed for gambling, and its mathematical relevance is not very high in equities. Yet, it offers meaningful insights for equity investing:
Focused Investing is the golden mean of the above two investment styles. Compared to 50+ stocks under Diversified Investing and 10 or fewer stocks under Concentrated Investing, a focused portfolio of 15-20 stocks offers the best of both worlds - adequate risk diversification and meaningful return magnification.
Disciplined practice of the above four steps should lead to exceptional returns rather than acceptable returns.
How allocation influences portfolio performance
Stock | Stock Return | Allocation | Portfolio-level Return | ||||
---|---|---|---|---|---|---|---|
Portfolio A | Portfolio B | Portfolio C | Portfolio A | Portfolio B | Portfolio C | ||
Stock 1 | 50% | 10% | 20% | 5% | 5.0% | 10.0% | 2.5% |
Stock 2 | 40% | 10% | 15% | 5% | 4.0% | 6.0% | 2.0% |
Stock 3 | 30% | 10% | 15% | 5% | 3.0% | 4.5% | 1.5% |
Stock 4 | 20% | 10% | 10% | 5% | 2.0% | 2.0% | 1.0% |
Stock 5 | 10% | 10% | 10% | 10% | 1.0% | 1.0% | 1.0% |
Stock 6 | 0% | 10% | 10% | 10% | 0.0% | 0.0% | 0.0% |
Stock 7 | -10% | 10% | 5% | 10% | -1.0% | -0.5% | -1.0% |
Stock 8 | -20% | 10% | 5% | 15% | -2.0% | -1.0% | -3.0% |
Stock 9 | -30% | 10% | 5% | 15% | -3.0% | -1.5% | -4.5% |
Stock 10 | -40% | 10% | 5% | 20% | -4.0% | -2.0% | -8.0% |
Portfolio Total | 100% | 100% | 100% | 5.0% | 18.5% | -8.5% |