By Amy Calistri
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The Dangers of Complex Investments
Keep it Simple
My Investing Approach in Three Steps
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My phone is an old Nokia about the size of a small brick.
It doesn’t take pictures, tell me the weather or connect to the Internet. That’s the way I like it.
In a world that has grown increasingly complex, I feel like a throwback to a different era. I like things to be as simple as possible—and that includes my investing.
As an engineer at IBM in my former life, I used to deal with complex problems … and solutions … day in, day out. That’s when I started to understand just how damaging too much complexity can be—no matter where it pops up.
Nowhere is this more obvious than the nasty recession we’ve lived through for the past two years.
For example, home mortgages were packaged and repackaged into mortgage-backed securities time and again until even the banks that invested so heavily in them weren’t sure just what they contained. The result was our government having to bail out the financial firms.
Meanwhile, complicated derivatives led to sky-high leverage around the investment community—bringing hedge funds to their knees.
Bernie Madoff even hid behind a curtain of complicated scheming to commit fraud on an unprecedented scale. But no one could really tell what was going on because of its complexity.
Is it any wonder that I like to keep things simple in my day-to-day life, but also my investment portfolio?
Judging from the investment landscape, many investors equate complexity and secrecy with smart investing decisions. How else can you explain the rise of hedge funds during the past several years?
These funds have very little regulation, usually use complex derivatives and futures contracts, and are generally tight-lipped about their investing decisions. To me, that doesn’t sound like it is in the best interest of investors.
In fact, in 2008 1,471 hedge funds shut down, according to Forbes. That was fully 15% of all the funds in the industry. And it’s been rocky for the industry ever since. In the first quarter of 2010, hedge funds had a net outflow of $11 billion.
So much for outsmarting the market.
My investing style is just a little bit different. Like I said, I keep things simple.
In fact, you could sum it up in one sentence: “Find one stock each month that will beat the market.”
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There are several reasons I like this “Keep it Simple” approach, and think all investors should follow it.
1. It allows investors to be experts on their holdings.
You’ve heard the phrase “Jack of all trades, master of none.” To me that describes a lot of investors. Portfolios with dozens—even hundreds—of securities run an extreme risk of having more than you can handle. But keeping a very focused portfolio allows any investor the time to go in-depth into a handful of select companies, making them experts on their operations.
2. It lets your winners work and cuts the losers.
We all have at least a couple of stocks in our portfolios that we don’t really like. For whatever reason it’s tough to let go of some holdings—even if we’re not hot on their prospects right now. But if you limit your portfolio size to just 10 or 12 holdings and use a “pig at the trough” game plan (only so many pigs can eat at one trough; if you add a new pick to an already full portfolio, you have to get rid of one current holding), you’ll solve this problem.
As a result, the dogs that you’ve always wanted to get rid of will stop wreaking havoc on your portfolio, and your holdings will consist only of those stocks you like the most. As Warren Buffett says, “It’s crazy to put money into your 20th choice rather than your 1st choice.”
3. You can’t beat the market if you are the market.
A funny thing happens as you add more and more picks to your holdings—your returns can suffer. Experts will always tout the benefits of diversification. And I agree with them … but only if you want to track the market. I’m more interested in beating the market.
The more holdings you own, the closer you are going to come to matching the market’s moves. That makes sense—you can’t beat the market if your portfolio is the market (one notable exception—using a “Daily Paycheck” strategy to earn consistent dividends, and reinvest). If you want to beat the Street, you need to pick your very best investment ideas and use them to power your portfolio.
Always searching for the next great idea,
Amy Calistri
Chief Investment Strategist
StreetAuthority Stock of the Month
P.S. If you’re like me and think investing simply just makes more sense, then I invite you to read more about Stock of the Month here. Remember, it’s just one pick each month, and I put real cash behind my picks. So far so good—my average closed trade is up 31.1%. Click here to learn more.