r/valueinvesting
Conviction is not how strongly you feel about a stock: a common beginner mistake
Conviction should be based on evidence, not just strong feelings; overdiversification often stems from a lack of true conviction.
I have been observing some of the sub-reddits where lots of stock tips and portfolio reviews are requested on a regular basis. Most of the posts are from people who have just entered the stock markets and are driven by enthusiasm to make it big in a short time by grabbing a multi-bagger.
I won't pretend to act high and mighty and claim to be any different. I fully empathize with such posts and actions. In my case, instead of asking for portfolio reviews and stock tips, I would quietly search the stocks I was interested in on Twitter to feed my confirmation bias.
The root cause is the absence of a real evidence-based conviction.
I used to have 50+ stocks in my portfolio in the first 2 years of my investing journey. When I realized how big a mistake this was, I didn't think it was a common mistake that beginners make. Now when I see portfolio review requests of many investors on different sub-reddits, I see how common it is. 90% of the time, these portfolios have 50+ stocks or less than 1-2% position in a single stock.
The explanation and diagnosis people dole out are: I was diverifying, and the answer they get is "Dude! You're overdiversified."
The real explanation is that many ideas exist in a state of perpetual maybe. Sized small enough that no decision about any of them ever feels urgent, which means no decision about any of them was ever actually made.
One of the solutions to this problem that people give away is "concentrated portfolio" and it's a controversial topic. Many people upvote this, and then some reasonably argue that this will destroy wealth.
The actual solution is to cultivate real evidence for the investment case, and the concentration will follow
A concentrated portfolio forces the confrontation. When a stock is 15% of your book, you cannot coast on feeling. You cannot size proportionally to your research time and call it done. You have to be able to answer, at any quarterly result, what specifically has to be true for this to be still worth holding, and whether it is still true.
Conviction is not how strongly you feel about a stock. It is how precisely you can describe what you know, what you're watching, and what would change your mind. And position size is one of the most honest statements of that conviction. Not because size proves conviction exists, but because when conviction is real, size tends to follow.
Conviction is by definition a feeling of how strongly you feel something being the way you see it.
nah that some noob shiiit. conviction : diamond hands, rocket rocket, to the moon.
\-OP
/s
underrated comment lol
Be careful OP,
Someone somewhere will take your suggestion and have a 10 stock portfolio, and if they lose money, they will come after you.
Just saying.
Thanks for flagging the misinterpretation that this post can lead to. Just to clarify, I am not saying concentration is the answer. My point is that "evidence-based investing" should be the go-to strategy for every one and my observation has been that when you do evidence backed investing, sizing often follows.
Btw I am not disagreeing with you. I too run a highly concentrated portfolios but I won’t recommended it at all.
Once again! I am not recommending concentration but the fact that you should put more efforts into your investments than a thinly spread position make you do.
And I have assumed that the people of Reddit are mostly retail investors with many below a portfolio size of 50-100k usd. ( I can be totally wrong here)
For a fund manager managing millions, of course concentration can be devastating and most would diversify at that stage. But for a large multi-million dollar fund even a 1-2% position can provide a sizeable return and move the needle. For someone with smaller portfolios below 50-100k, the diversification can be achieved via a couple of ETFs and a debt fund and that will do a better job than thinly researched platter of stocks.
I don’t think a retail investor with small sums should act like a fund manager. Fund manager and people with large money has constraints and advantages which don’t apply to people with smaller capital. Concentration is not something you choose as an investor with small sum (large money people chooses it), it’s a resultant of high-conviction investing. Because when you develop high conviction in a few stocks, you won’t have capital to allocate as per your conviction level if you have spreaded yourself thin.
I think OP is also talking about volumes, do not have a 50k porfolio with 50 stock, with that amount stick to 4-10 stock
Conviction is how well you can deny anything that might disprove your beliefs. 😜
Disagree, conviction has nothing to do with evidence. You could be deluded but still have conviction in a stock. Whether your conviction pays off or not is a different conversation.
It's okay if your risk tolerance is different but don't proselytize please
You need conviction through evidence, if you just believe a Stock will do good , you will sell with a loss as soon as it drops because you start questioning yourself and that's where people loose most money.
If you know that the whole market drops you also know that this doesn't change any fundamentals of your picks, it just offers a good opportunity to buy more.
Having a large portfolio is just spray and pray investing.
It’s becoming increasingly manageable with today’s tools (especially AI) to hold a “well informed” portfolio of 50 stocks. This wasn’t possible just a couple of years back. You are not going to be as “on top of things” as you would with 10 stocks (the depth gets watered down), but what you lose in conviction you gain in diversification. You are much less likely to sell a 1% holding if it goes 40% down, than a 35% holding. Also if you spread your porfolio to a wider range of names, you increase your chances of potentially catching a 10-bagger or a 100-bagger. One stock like that can severely change the performance of your portfolio and turn it into an outperformer compared to even much more concentrated portfolios. Moreover, retail investors don’t have the kind of knowledge and access to information hedge fund managers do. Most of us are “know nothing investors” as Buffet calls it, and for “know nothing investors” the best thing to do is to diversify (even Buffet said so many times). Also, the reason why concentrated porfolios seem better is survivorship bias. You only see successful ones in hindsight, you never think about how many of such portfolios lost money. There have been numorous studies on that, and people have proven it to be right.
You don’t need a secret information edge to do well with your stocks. You need a system to stay disciplined and consistent. Pre-defined business specific conditions to base your decisions on. Information is hardly an edge for long-term investing.
On the increased chances by spreading yourself too thin - yes you will catch a few 10 baggers, even I did in my initial era with a platter of thinly researched stocks but they didn’t move my portfolio in the slightest because how small of a position I had in them. The point is not to catch multi-baggers but get consistent returns better than index or else you are better off investing in the index. And in my humble opinion (no data, your words against mine) I think a small portfolio (below 50k) with 1-2% positions size has a bleak chance of doing that.
I don’t know. At the end of the day, it also comes down to personal preference, mastering your own psychology and your risk tolerance. You can be disciplined and have a system with 10 stocks and with 50 stocks. As people pointed out, there are many famous investors who did well with both concentrated and diversified portfolios. It doesn’t need to be black and white.
I don’t agree that AI makes it substantially easier to “know” 50 stocks. Maybe a little bit easier, as it’s good for summarizing data, but you can’t fully trust that data and you are competing against people who have access to the same tools, limiting any alpha you can get from relying on AI.
Retail investors may not have access to the same rails in terms of information and resources, but are also not beholden to the same limitations. If I lose money during a green year investing in some company no one has heard of, I don’t have to justify myself or risk losing my job (even if I believe it is still a great long term opportunity). I can take much more concentrated positions and focus on maximizing total returns over the investment horizon that fits my needs rather than releasing yearly reports to clients and putting out fires if I lose money - a system that inherently favors less volatility. We both want to optimize risk-adjusted returns, but I’m not bound by keeping volatility low and can be more patient for a better end result.
It seems silly to me for a retail investor who wants to pick stocks to ignore the advantages they hold over professionals. Always play to your advantage.
Very well explained! The advantages of a retail investor with small capital.
I invest in indian equities, and it hasn't been good for the last 2 years. The major index Nifty50 has given almost 0 returns, and so have most of the fund managers. But if you see the broader market, a lot of companies have done great, especially the mid-caps and small-caps, which are undersinvested by institutional investors. But these are the exact opportunities a smart retail investor can exploit.
On AI being a great help, it surely is, but not really an edge, and it saves some time, but not enough to manage 50 positions for a single person. I was researching an indian company called "Jyoti CNC" and the company saw dramatic margin expansion post 2022. Management credited the margin boost to product mix changing and everything looked great. But there was a catch, a litigation against one of their subsidiary in France which AI conveniently flagged as normal routine audit related checks etc. I checked out Valuepickr, which is a community of serious investors in India, and it has decade-long threads on companies where people share detailed information. I found from that thread that the litigation was in fact an extremely serious one. Apparently, the French arm was exporting some goods that had dual use (military as well as civil) to Indian company which would send these exports to Russia, bypassing the sanctions on Russia. Now this was not a routine audit-related litigation that AI highlighted, and this explained the mysterious margin jump from 2022 after the Ukraine-Russia war. Then I went on to grill the AI for overlooking such an important detail because I could, and expect no one to yell back at me 😛
Yep, I think one of the fundamental principles is playing to your advantage. That’s why we try to select stocks with the most asymmetric upside vs downside potentials. That’s why we pick the games we play with stocks that suit our strengths. It’s what differentiates controlled risks from gambling.
Incidentally, one of the things that seems quite ideologically inconsistent is how many people preach diversification, but see no issue with owning a home. Yes, it’s not really an investment, more of a lifestyle decision, albeit one with major financial implications that a lot of people do depend on to fund their retirements. It just seems crazy to me how many people will aggressively diversify a few hundred k portfolio, but take on crazy amounts of leverage on something that makes up a high proportion of their net worth with completely speculative value (ie unless you’re cash flowing your own home through rentals, it’s not producing value and its future value is entirely dependent on the whims of your local real estate market conditions when you sell).
Using AI may not give you an edge anymore, but NOT using AI will definitely put you at a disadvantage to pretty much everyone else.
And it is substantially easier to reasonably know 50 stocks. Research that used to take many days and teams of people now can take just a few hours for a single person to do. If you can’t see that, it just means you haven’t used AI the right way.
I mean it’s not going to make listening to EC any quicker and you should be fact checking it
Might actually be a good thread to see how people are using AI
"Conviction is how precisely you can describe what you know, what you're watching, and what would change your mind." This needs to be pinned
Haha, glad you think so. Reddit should have a feature to pin comments. At least I will do that on my twitter.
Hot take: over monitoring isnt that useful. Few theses plays out perfectly and if it was as easy and buying/selling based on latest reports and guidance, investing would be mathematically solved.
Buy right and hold on tight. End up owning 50+ stocks. Youre not whatever survivorship bias trader that inspired you to own 10 stocks max lol
This is one of the best posts on this subreddit. Well-written. Good job.
I will add a small corollary: if you don't have the time or inclination to do the research, then diversification IS the right strategy.
In my case I do a mix: 50%-60 of my personally managed portfolio is in 3-4 high conviction bets. The rest is a motley collection of 30-odd businesses that I like but don't have full conviction on. There, diversification is a hedge against the fact that I might be wrong or stupid, but where I feel that a basket of those, selected for financial criteria I believe are important would still do well.
thank you! I agree with your point. If you don't have time and you don't enjoy studying the businesses, then passive investing and high diversification are amazing. I became an active investor because I love reading about businesses.
Since last year I have started an experiment where 40% of my portfolio is in direct 7-8 stocks and rest is mutual funds, a debt fund, and a couple of ETFs. My experiment is to beat the 60% for next few years to have enough performance data and gradually shift the weights if the results are positive.
Yawn… All these experts… Post your portfolio and percentage returns over the past year, which shouldn’t be hard to do in a Bull Market.
Otherwise Shad’Up and keep your bullshit advice. I listen to people that do, not people who pretend to teach.
It should be the degree of edge, not conviction, that serves as primary driver of a portfolio’s concentration. A deep value investor may have a very concentrated portfolio consisting of only a few positions, each in which they are convinced they have a massive edge. But a market maker may have a book of hundreds of positions, each in which they have even greater and more justified conviction than the value investor, but in which there is only a slight edge.
It should be the degree of edge, not conviction, that serves as primary driver of a portfolio’s concentration. A deep value investor may have a very concentrated portfolio consisting of only a few positions, each in which they are convinced they have a massive edge. But a market maker may have a book of hundreds of positions, each in which they have even greater and more justified conviction than the value investor, but in which there is only a slight edge.
Well this us disconnected from reality