Foreword: 2020 has been such a challenging year to invest in, with the sudden market’s reaction to the COVID-19 situation and many uncertainties in the macro economic situation. Achieving a return that outpaced the S&P 500 index was not a smooth ride, but in fact a bumpy, and at times, a traumatizing one — where I saw a drastic drop of -50% in portfolio value back in March.
Hence, I decided to write this article on what I did right and wrong for my portfolio this entire year to share my journey, so that readers can avoid the mistakes that I made, and be presented with new ideas that could shorten their learning curve as a retail investor.
Mistakes that I made in 2020:
Portfolio Allocation/diversification:
I used to hold many companies and diversified as much as I could, but I realized that heavy diversification for my small capital size did not make sense numerically. As seen from Fig 1, imagine that a company(Company A) in your portfolio went up by 60% but you only invested 10% of your capital, that would only mean that you gain a 6% in overall for your entire portfolio. Alternatively, imagine if you invested 60% of your capital instead in the case of Company B, then a 60% increased would mean a 36% increase in your overall portfolio. As an extreme example, in the case of Company C, even though the % gained from buy price was only 30%, because of the % of capital that you have invested, which was 30%, the % gained in overall portfolio was 9%, which was still higher than that of Company A.
It dawned to me that if I wanted to move the needle for my portfolio, I needed to be concentrated. For the more diversified I am, the more I was exposed to risk of owning lesser quality companies in my portfolio, and my winners would not move my portfolio substantially. However, that does not mean to put all my eggs in one basket — it just meant that I should allocate my portfolio according to conviction that is backed by research. Companies which I felt that had a better risk-reward ratio were given a higher allocation, instead of just blindly following an allocation of let’s say a fixed allocation of 10% per company for 10 companies.
Engaging in too many trades/speculations:
The Pareto Principle, which says that 80% of the results is determined by 20% of your effort or actions applies to investing as well, and I learnt this the hard way. This year, I did some unnecessary trades that were purely based on speculation and this was detrimental to my portfolio, where I sold some of these positions at a loss.
Doing less is more and looking back, only a small portion(perhaps 20% to 30%) of my trades were impactful in terms of contribution to returns for my portfolio. At the end of the day, I realized that buying and holding, instead of craving for unnecessary activity was the most effective way for me to invest, without putting too much stress on myself.
Price Anchoring:
The picture above often resonates with many investors, since it is difficult and counter-intuitive to buy a stock that had risen in share price by a lot compared to your previous buy price. “Price anchoring” — or the cognitive bias of letting a certain price dictate your decisions, was another critical mistake I made.
Businesses were never meant to stay stagnant, and when they grow rapidly, the valuation tagged to them increases. Thus, it is only reasonable that the intrinsic value of the company will increase accordingly and the increase in share price should be a norm to accept if the company manages to grow the business. This further justifies the importance of valuation which will be a guide for the price range that is fair to pay when averaging up on the position (buying more of a stock even though the share price went up significantly higher than your original buy price). Do not be too caught up with the share price, for what really matters is to get the shares of a quality company. Let the share price serve you, and not the other way round.
What worked for me in 2020:
Focusing on investing in mission critical companies:
Mission critical companies are companies that are deemed as “anti-fragile”, companies which will still thrive during economic recessions. These companies usually have several characteristics, such as providing essential services or products that are indispensable, such that customers will not need to think twice on spending on such products or services. An example would be on Customer Relationship Management(CRM) software. Would companies think about not using the software if a recession hits? Probably not, since it is an essential part of the operations for many companies. One other example would be security, if a recession hits, will companies decide to forgo on security? Probably not, since it jeopardizes the safety of employees, and the data of a company in terms of cybersecurity.
Having a strict criteria for companies in your portfolio and thinking about the business models is essential in building a portfolio that will continue to grow in spite of challenges in the macro economic landscape.
Being aware of secular trends and understanding their value proposition:
Secular trends are general economic trends which the world or market is generally moving towards to. These trends may sometimes not be apparent yet in our everyday lives because change takes time to take place. Having an awareness of such trends will let you better gauge the Total Addressable Market(TAM) and the Compounded Annual Growth Rates(CAGR) of nascent markets. Having a growing TAM is important since this would mean more growth for the companies that are operating in these markets and their growth would not necessarily be at the expense of their competitors.
COVID-19 has accelerated many of such trends, such as usage of E-Commerce, transitioning towards cloud based platforms, the increasing adoption of digital payments and data analytics. Being aware of these trends will give you an idea of which potential industries to look at and thereafter, which companies to look at. Understanding these trends and recognizing the value that is being brought onto the table will also give justifications for premiums in valuations when looking at the share price in some of these companies.
Understanding intangible assets:
Inevitably, some businesses are much more superior than others and as investors, we would want to identify businesses that have an economic moat, with examples such as branding, network effects and economies of scale. It is the very same reason why coca cola is still one of the most popular beverages and people are still willing to pay for it even if the price increases. One other example would be Apple, where their branding has given them the ability to have the pricing power for their products.
Recognizing these intangible assets is crucial because many times, these companies are able to use these assets to create an even better product, or even used the extra margins from the pricing power that they have to innovate even more products.
Accepting that it is okay to not know everything:
It is okay to not know everything, given that there’s just too many listed businesses that have business models which you may not understand. What is really important is to only invest in companies that you understand, while growing your circle of competence! Accepting that you do not know everything will relieve the stress of investing, given that sometimes we have to make decisions when we only have 60 to 70% of information that is needed. Just be comfortable with yourself and understand that as long as you are continuously trying to optimize your upside and reduce your downside, the odds will generally be in your favor.
Conclusion:
“Do not take yearly results too seriously. Instead, focus on four or five-year averages.” — Warren Buffet
I can easily say that I do not know everything, but I continuously try to learn new things everyday. Even though this year may have been a rather bumpy ride, as the quote above suggests, it is much more important to stay humble and focus on achieving sustainable returns over the long run, which will be my aim moving forward.
Hopefully this article has managed to add some sort of value to you! If you enjoyed reading this post please clap away and consider becoming a follower! Please do share this article with anyone else who may enjoy it too! Thank you for reading!
Disclaimer: I am not certified to give any financial advice and the entire article above is just an opinion of my own. It is not a recommendation to do anything. Please do carry out your own due diligence before making any investments or seek a certified financial advisor if necessary.
Thank you!