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Good enough is good enough

In a good investment portfolio, making a few bad choices is inevitable and not worth worrying over

Good enough is good enough

Better a diamond with a flaw than a pebble without. Perfection is the enemy of the good. These and similar sayings are common in many languages and cultures. They all mean the same thing. If you get obsessed with getting the best results possible, then you are likely to actually get worse results or not be able to get to the goal that you had set out to achieve. Most of us, professionally and personally, understand that good enough is good enough.

Investments are a different matter. Too many investors feel that all investments that they (or someone) choose must do well or else there is some problem in the method of choosing them. Some years ago, I wrote about a certain style of analysis that some mutual fund experts had adopted. They would go through the past portfolios of equity mutual funds and hold up examples of stocks that the fund had bought but which had not done well. This was then used as an example of the poor quality of fund management. The problem with this approach is that it completely abandons the idea of an investment portfolio and of the value of diversification.

When you are evaluating an investment portfolio, then there are going to be some stocks that do not do well. Sooner or later, most experienced and realistic investors come to the conclusion that perfection is not possible. If you aim for perfection, you will be immobilised into inaction and your money will spend a lot of time sitting in a savings bank account or moving in and out of investments at every little bump.

The example that's closest to me personally is that of the Value Research Stock Advisor service that my company launched almost four years ago. During this time, we have recommended close to 50 stocks, with companies from all kinds of industries, sectors and backgrounds. Needless to say, my personal investment portfolio also consists of these stocks. During this time, we have had a few stocks that have done badly. However, a bulk of the stocks have done well and a certain number have done extremely well. All in all, the portfolio has been a good one.

Should I obsess over the ones that have done badly? Certainly, we give them enough analysis about what happened. Not just to companies themselves but our own thought processes and logic. However, we don't worry about it. The cure for the occasional failure is NOT to try and achieve perfection in your investments but to ensure that your portfolio is large enough and diversified enough.

However, once you understand the reason why an investment portfolio exists and why diversification has any value, it becomes clear that what matters is the overall performance of your investment portfolio and not that of any individual investment that happens to have done badly. As an investor, I do not worry about failures. There has never been a portfolio which, over a sustained period of time, does not have some bad stocks in it. That is the way equity investing works.

The solution to this is obvious: the oldest risk-control measure in the world, which is diversification. The theory of diversification is very simple. All investments don't work well simultaneously. The normal state is for some investments to do well and others to do not so well or even badly at a given time. If you happen to be over-invested in something that is doing badly at one time and not at another, then you are going to have a problem. The utility of diversification is in saving you from poor performance in a narrow set of investments. If a particular company or sector is in problems, having only limited exposure to it helps. Apart from sectors, diversification should also be across company size as sometimes only smaller or larger companies do well or do badly.

Of course, this is something that has to be done and maintained, which is why closely tracking the actual diversification of your investments is better than choosing investments and then obsessing over the bad ones.