Investing is more than just finding the next "multi-bagger." Having a sensible portfolio strategy is equally important.
Are you a day trader?
Say you hold 100 stocks with 1% invested in each stock. 1% times 100 = 100%.
This is a common portfolio construction. Usually born out of a strong desire to diversify away all risk. If you invest in a mutual fund through your 401(k), very likely your fund holds more than 100 stocks.
Say your holding period is one year. You buy a stock, hold it for a year and sell, hopefully at a gain, locking in long-term capital gains.
Clearly a prudent strategy.
No one will accuse you of being a day trader.
Time for some math..
Continuing with our example, if you hold your 100 stocks for a year, on average, then you're effectively selling 100 stocks, or 100% of your portfolio, every year, on average. For each stock you sell, you need to buy another stock. So your're effectively buying and selling 200 stocks per year, on average.
But wait it gets more interesting...
You never buy your entire position at once. What if you buy shares of a company, and the stock falls another 10%? The more "prudent" approach is buy your shares in installments.
Say you buy half the shares one week and the remaining the following week. So now you're effectively buying and selling 400 stocks per year.
Any major brokerage firm will likely charge you around $9 per trade. That amounts to around $3600 ($9 times 400 trades) per year.
Let's say, you have a $100,000 portfolio.
You're effectively losing 3.6% ($3600 divided by $100,000) in trading commissions alone. You need to earn 3.6% in investment gains just to break even!
Is it any wonder that excessive diversification ("di-worsification") can lead to sub-optimal results over the long term?
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