If you had always thought that effective equity investment requires you to spend hours reading up on a company’s business, its income statement, balance sheet, financial ratios, strategy and more, that is not entirely true! Contrary to popular belief, the amount of time required to maintain your portfolio starts to fall once you have a large number of equities in your portfolio.
The Four States of Equity Investment
State 1: Single Equity Investment
There is zero diversification, and the investor only has a single equity under his equity portfolio. Needless to say, with this equity taking up 100% of the portfolio, it is of extreme importance for the investor to keep track and pay attention to its performance to decide when to buy and sell.
State 2: The In-Between
As you begin to diversify your equity portfolio, the time commitment required increases. Since diversification is done minimally, each of the equity still contributes significantly to your equity portfolio. For every additional company that you invest in, it is still necessary for you study the firm, to decide when to buy and sell. More time would be required for every additional new company that you invest in.
Here’s a quick illustration: Let’s say you have equities from 10 different companies, each of them would still take up 10% of your portfolio. Inadequate supervision on just one company could impact up to 10% of your portfolio performance.
State 3: Economies of Scale
There is no magical number as to when you would achieve “economies of scale”. At some point when you have a large number of equities in your portfolio, you can start paying less attention to the performance of individual companies that you have invested in. This is because each individual company would have a very limited impact on your overall portfolio performance.
Instead, you can start grouping these companies along sector or geographical lines. Tracking the developments of a single sector or country takes way less time as compared to having to juggle 30-40 companies.
State 4: Effortless Investing
This is the epitome of diversification (and effortless investing). This is when your equity portfolio covers almost all geographic regions and sectors. Each sector/country would now have a very limited impact on the performance of your portfolio. This is the point where you do not even need to care about the developments at specific countries or sectors! The only way you can lose money on your investment is when more than 50% of the world suffers an economic downturn.
This technique also goes by the other name – Passive Investment Strategy. Stay tuned for more on the risk and returns of passive investment strategy!