All about portfolio construction. July 21, 2023

23:57There's no second best when it comes to that kind of thing. So I agree with you. I think that is why, at least for long term, I would never invest a cent in the money if I needed it in six months. So let's also put that in context. But for any long, meaningful period of time, I'm really talking five years plus, hopefully longer than 10 years plus, what else are you going to do? What else are you going to do? It makes incredible sense. And just to be fair to property as well, I mean, property, as we've said, just the objective truth of it, has on average been slightly less than shares. It kind of has to be, right?

24:35Because again, what can you do with it other than rent it out in terms of, you know, and okay, you can raise rents and stuff, but there's a limit to that, right? CSL could increase its profits 20 % next year and do that for 10 years. You can't do that with a property, right? Actually, I was saying to you off air on the long weekend, I ran around to a thousand kids parties, you know, and I was chatting to a couple of the dads there. one of them made the observation they're talking about property of course right of course and they said i know you don't you don't like property and i had to clarify and i just i think it's worth doing here as well i've got nothing against any asset type right but it's always just got to be looked through the lens of risk versus return and i think just want to make that point here if i could buy a house now it was a really good condition i thought it was reasonably scared There was a fair amount of scarcity there.

25:28It was in a good location and the rest of it. And I could get a 4 % yield on that back up the truck, right? Like, don't get me. I've got nothing against property whatsoever. I've got a huge problem with property right now when I'm getting negative real returns, and especially after costs and the rest of it. So that's, I think, and that's why it's sort of hard to have these set figures of you should have X percent in bonds and you should have X percent in this. There will be times, while you can't predict and time how markets will turn, I think you can not forecast, but now cast, to use that term, which is just to sort of say, rubber bands can always be stretched a little bit further than you think they can.

26:12And things can always last longer than you think is sort of possible. But I don't really need to predict the future now just to sort of say, you know, there's a million homes for my capital. and on a risk-adjusted basis, on a return-adjusted basis, one just looks objectively better right now. I don't know when the market will finally agree with me and recognize that. But again, the lessons from history are pretty strong here. It's like if you sort of make generally a decent investment, that isn't realized. It's usually not realized immediately, but it usually does be realized eventually because there are – it's not physics, there's not laws of the universe here, but there is a certain gravity with financial matters that after a while, it's very hard to sort of ignore the economic reality of these entities, which just keep spitting out ever-increasing sums of cash flow.

27:04The market might miss it for a while. It might ignore it. It might doubt it for a bit. But as long as that continues, it's going to work out, which is why you need that long-term lens on it. but yeah i think what's fascinating to me mate is and this i want to get off property and i think we'll move to shares because that's kind of our bailey week in a second but um so a couple two thoughts one is that we also need like i started by saying there's a theoretical answer and there's a kind of a pragmatic answer to these questions and i've said lots of times you've said lots of times the right thing the mathematical mathematical best outcome is not the best outcome for everybody because we're human, not robots and machines, right?

27:42And so if you're someone who needs to sleep at night of cash in the bank, then you know what? That's better than not sleeping at all or buying and selling stupidly because you just let emotions overcome you because you're so strung out by the whole thing. It's just too freaky. If you're going to panic every time there's a 10 % drop in the market, don't invest in the market. Right, exactly. So, or have other things as well. So you feel like, okay, well, there's 10 % drop, but only 6 % of my money is in the share market, at least the other part's in something else. And that's not going to drop as much or as far as frequently.

28:11So at least 10 % drop in the market means a 5 % drop in my overall portfolio. I can cope with that. So there's ways that that's where asset allocation is personal. There is a theoretical answer in my view, which is if you've got the timeframe and the stomach, I'm 100 % cash, 100 % cash, 100 % shares for a very, very good reason, 0 % cash, for a very good reason in my opinion. But I have a cast iron stomach as to you. We've been here long enough. We've done this long enough and often enough. By the way, when I say cast iron stomach, I'm not saying it doesn't matter. it sucks like it really genuinely oh yeah i stare at the ceiling late at night on many a night right but we've we've been we've i talk about the fact i've separated my brain to two parts right the part of me that during the covid crush went oh my god this could be terrible what if this really does reshape you know life uh there are those who were talking about the gfc as the end of capitalism right there are there are there are there's always those doubts there's two parts of my brain the part that emotionally goes oh man this sucks the other part that goes okay but suck it up philips you know how this goes keep doing it anyway and as long as that other part of my brain can you know have have the whip hand when it comes to what i actually do then i'm okay and i think that's it's important because i don't want to i don't want to suggest to people you have to get to a point of not caring at all when your portfolio falls must have been 30 35 40 whatever it was during that period i haven't gone back and looked i probably should for the fun of it now because i can in hindsight but you know you don't don't think you can't do this until you've genuinely chosen not to care.

29:37It's not that you don't care. It's that you care a lot, but you do it anyway. That's the breakthrough for me when it comes to investing. Just on that, do you know what drives me in those situations? It's fueled by a fear of future regret. Nice. It sucks going through it and every instinct is saying, get out, get out, run and seek safety. But again, it's not my first rodeo, right? And I've said many a time, my biggest regrets are not the losses that I've made in certain periods or even outright on certain shares. It's the, you get the fat pitch and you're too nervous. And then, you know, three years later, you look back and go, well, I'm glad I bought some, but what the hell was I thinking, right?

30:21And it's not just survivorship bias as well. It's just sort of like, I really just should have gone hard on everything, even the ones that didn't work out. Because overall that was, and I knew it, right? And so when things get really scary, that actually drives me a lot. I think, well, that sucks, but I don't want to be looking back in three, five years time going, you idiot, you know, why didn't you take advantage? You always say you're going to take advantage of, you kind of hope for these situations in a bit of a narcissistic way. So yeah, that drives me. I like that a lot. The other thing I'll just quickly say and we'll move on to company or share specific portfolio construction is when I think about, Now, you mentioned sources of return, right?

31:01Now, I want to be really clear. Any asset can be mispriced. Any asset, a bond, a term deposit, potentially it's not likely to happen. I mean, it's possible you look at something and go, well, that's obviously too good to be true. For example, if you could have fixed a loan at, hey, 2 % three years ago and borrowed a reasonable amount of money that you could still pay off when rates rose, it wasn't exactly mispriced, but that was a pretty fat pitch if you want to borrow some money. Talk to US investors. Like if they get 30-year fixed rate mortgages over there, right? Right. Can you blame them? Locking 2%.

31:31Yeah. And then by the way, there's also companies, I think Apple did it. Was it a 100-year bond? That's right. Who bought that? What idiots bought that? Anyway, that is this whole other conversation. Well, so there are always individual opportunities to buy or sell an asset at a really attractive price. I mean, Ben Graham, Warren Buffett's mentor, talks about Mr. Market who knocks on the door every day and says, hey, what about this price? And you can choose to buy or sell at whatever price he suggests. And every now and again, you get a great price. Like, well, okay, I guess I'll sell. If someone walks up to me tomorrow and says, I'd like to give you$10 million for your house, Scott.

32:06I'm like, I will literally drive you to the solicitor office right before you change your mind. In fact, speaking of which, Warren Buffett talks about, I can't remember which company it was. I have a feeling it was Geico, but it might've been National Indemnity. One of his insurance companies years ago, the bloke he bought it from, Buffett had basically said to somebody, hey, this guy twice a year, This guy just has enough of dealing with public markets and he just has enough. He's like, bugger it, I'll sell the business. And Buffett said to him, look, next time he says that, tell him to call me and I'll do the deal.

32:32And so the guy calls him, Buffett does the deal and the rest is history. So every now and again, a business owner or a, and that's what shareholders are, business owners, or a property owner or a bond owner offers you a stupid price, you should take it. So at an asset level, not just asset class, an individual asset level, it's absolutely worth paying whatever price, if the price is right. Right. Equally, so, you know, I'll go straight back to property here. What's the source of excess return from property? Now, everyone has, almost everyone has a home. We're getting a homelessness and rental stress in a minute, but everyone has, properties are all, you know, they're all owned.

33:09You don't really have a choice not having a roof over your head if you can possibly have one. So there's that. The price is largely set by an ongoing market mechanism where there's not a lot of opportunity there are so many people in the market at any given time even though only five or five years of houses change hands every year there are going to be more than one bidder or potential buyer for every house and equally everything sold is going to be sold into active market the chances of a of a mispriced individual asset is just really small because the way these things work right just is the way it goes um and because frankly we believe even if erroneously that the future is knowable or that pricing is kind of you know it's a set percentage set yield set whatever property tends to be pretty i will say efficiently priced mate you you and i can disagree probably with the market i disagree about what a reasonable price is recent terms but yeah but what i mean is that the market is deciding as a group that this price is the price that we're all prepared to pay it's like one house goes for a price that's half the other house in terms of rental yield or whatever you know a two bedroom four you know a four bedroom two bathroom one garage house in a given suburb you can pretty closely work out what it's going to sell for the chance of finding a bargain is really, really narrow.

34:19For whatever reason, and well, so whatever reason, the reason is because the rental yield is kind of knowable, right? You kind of know that if I don't buy it, you'll buy it. If you don't buy it, someone else will buy it. Or if I don't rent it, you'll rent it. If you don't rent it, someone else will rent it. The inputs into the algebra are pretty knowable within a very narrow range. If you ask yourself, what's Amazon's profit going to be in four years' time? I own shares, everyone knows that. Or JB Hi-Fis or Catapults. Because of that inherent uncertainty, because you can't rely on, well, everybody buys a product from Catapult.

34:49We all know how much they sell and we all know how much they cost. And there's a reason why Woolies Profits more knowable than Catapult's, right? Yeah. Because it's just a different thing. And by the way, if properties overpriced, so Woolworth shares for probably similar reasons. But the opportunity for the individual investor is to take advantage of a non-comparable market. You know, four bedroom, three bedroom, two bedroom houses, units. They're not a dime a dozen, but there's enough of them that the price is knowable, right? Think about how many houses are there, eight million houses in Australia?

35:17There are 2 ,000 companies max on the ASX. The sheer ability to compare those and to know with certainty what A, they're worth and B, what the future is going to look like. Imagine if you had to say, well, in five years' time, the rental yield of that property might be 1 % or 4%, I'm not sure. So how much do you pay for that? It's really hard to know. But the same is true of shares. That's why there is so much, frankly, discount because of that uncertainty. It's also the source of our upside, as you suggest. Yep. Yep. Absolutely. I mean, your error there, it's not an error at all. It's completely cogent, rational thinking, but the error that you've sort of touched on there is that you assume that people are making these decisions based on cash flows.

35:58And I'm very, very firmly of the view that that is the ultimate source of value, really. Why would any asset have value if it doesn't generate some kind of cash flows? And obviously the higher the cash flows, the better. So yeah, I think that's, I think it's a really good point. I mean, I don't know what the yield might be in the future based on then prices, but I can know that I'm probably able to rent it out for this amount. And I can probably over time increase that with more or less, you know, recent periods have been an exception, but more or less in line with inflation. It's a very, it's a much easier proposition than trying to forecast company earnings when you go out.

36:35That's the great thing of property. I think, again, just very quick segue, but I think that's where the the market has become very efficient because over the decade, last two decades or so, it hasn't been about income at all. It's been entirely about capital growth. And capital growth has been entirely fueled by cheap credit. So it's sort of like we're in the bizarre situation where people are actively intentionally structuring their investments to lose money so they get a bit of a tax gain, you know. So you're right. You're right in any particular. But I would just – I think that's where – and the market too.

37:08Let's not keep – that is a separate case. That is why things got really crazy 2020, 2021. It was the interest rates, you know, stupid. That's what – Woolies – no one had any great shock and surprise in what Woolies was going to do, but all of a sudden the amount that people were prepared to pay for those earnings changed radically. So, what's my point here? My point is I just wanted to jump on that one that you made. It's just like always focused on the cash flows. And then you can work – it gives you a base to sort of work around that isn't just purely anchored on the speculations of irrational emotional human beings.

37:53And I think that's why – Just to expand on that, why would I – if the only way I'm going to realize value is through what they call the greater fool theory. In other words, this makes no sense relative to the cash flows, but I'd probably be able to sell it to some other idiot for a higher price in the future, whether that be a share of property or whatever. It's just a risky proposition. But if you own a range of investment properties, and then for whatever reason, the property market closes, I don't know why that would happen, but imagine if it did, who cares? Who cares? I'm getting this wonderful stream of income.

38:26It's its own end, right? And I think that's the same with shares. Buffett talks about it all the time. You should be happy if the market closed for 10 years? Who cares? Because the share, the proportion of the business you own is putting money or at least has the potential to put money in your pocket each and every year. And hopefully that increases over time. If I need the market or if the only way I can realize any return is by flipping it to someone else. And the very act of holding it provides me with nothing. That is a pretty ordinary investment. That's not an investment. That's a speculation.

39:01and i think so i i'm gonna i'm gonna agree with you but also say that there is an there's also an element of that regularly in the share market oh yeah yeah because even you're about 2021 i think you're partly right about interest rates mate i think the problem is that even when we start to rash when we try when we start to believe there's a rational cause for an emotional response i think we run the risk of maybe only painting half of the picture because i think if you look at and let's take a really simple example right the 1999.com bubble right there wasn't that wasn't cheap rates that wasn't there was there was you know there are times when simply people went hey this is that thing might be huge let's all buy tech stocks and then as that felt like 80 or 85 percent between 1999 and wherever it bottomed out in 2000 2001 and i think the the i think the point i just wanted to make i suppose is if you look at the the way we talk about the way you just market as a whole.

39:59And I think that's where, if I go back to the value of shares as an asset class, the opportunity I think we have with shares is to be able to say, A, I won't play during that period of time, I'll play another period of time, or I'll buy the companies that still make sense despite that. Again, you talk about Berkshire Hathaway, those shares fell, was it 20 % during 99, I think? And the market was up 25%. Berkshire underperformed by massive amount, right? Huge. You didn't have to buy the NASDAQ stock, you could have bought the Berkshire shares. equally even if you'd been dollar cost averaging through that period of time and people always say oh well yeah look you know the market hasn't recovered from its 2007 peak as if as if that's the only thing that mattered but if you're dollar cost averaging before during and after you bought it a much much much cheaper price over time it's a bit of a magician's trick of look at that one peak if everyone invested only on that day we've talked about this before it's about the unluckiest bastard in the world if you'd have just invested on that day and then never before and ever since to now, yeah, maybe your returns hasn't been as good as you would have hoped.

40:56But you would literally have to be the unluckiest bastard in the world because the rest of us were investing for the 10, 15, 20 years before that and the 20 or 16 years since then and we'll continue for the next X number of decades after this. To pick only one point and say, yeah, well, it hasn't got back to that one point yet is kind of madness, right? Yeah. So I think from an investor's perspective, I just want to make the point that the market can be equally irrational from time to time. Hence the talk we had about things falling. I mean, the property market's unlikely, in my view, to ever crash in the short periods of time by as much as the market does when it has a bad day.

41:27But it's unlikely to go as well either. And over time, I still expect shares to do better. So I don't want to point... I don't want to say the share market is the rational place to play and the property market is an irrational place to play, at least at the current price. Yeah. It's simply a case of emotions are emotions across the board. Frankly, they give us... You talked about the future regret thing. I mean, when the market freaked out about COVID, that was a great time to buy. I know it's harder to do than to say, but there's plenty of irrationality to go around. The challenge, I think, with, go back to your point about earnings power, how do property prices go up?

42:02Well, there are kind of three components. There is income, there is interest rate, and frankly, there's another version of income, which is just the rental income for those who are providing the return. So I say income is in wages. So if my income goes up, I can buy a more expensive house to live in. If rates go down, I can buy a more expensive place to live in. Or if the rates of other people go up and they can pay me more to rent, then I can pay a bit more for that house because I get on a yield basis. That makes some sense. One other quick thing, it'd just be the very access to capital as well.

42:34So just general lending standards. True, true. Yep. Same thing though, right? Well, but again, yeah. So I guess my point is think about the entire residential property market in Australia. Once you adjust for interest rates, I think, frankly, we have done that over the last 18 months, for better or worse, probably for worse for many people. Once you adjust for rates, once you equalize for rates, how can prices go up? Well, can I go up if you can afford to pay more for them? How do you afford to pay more? Well, only you get paid more. Now, let's take that all the way back and think about how much wages have or haven't increased over the last 20 years and are likely to in the future.

43:09They're likely to grow at GDP-ish plus productivity. So overall, despite the evidence or apparent evidence of the last 30 years, Frankly, and we can go to that, probably not now actually, but another time, the drivers of house price increases over the last 30 or 40 years, not just the last 18 months or the low rate decade before that, but over the last 30 or 40 years, come down to those factors. We had second incomes in households. We had lower interest rates. We had longer mortgages. We had lower loan to valuation or higher loan to valuation ratios, lower deposit hurdles. Those things let people jump.

43:44Banks are just throwing money at us all, right? Banks were throwing money at us. But what else do you do? You can't add a third income to a household. Rates have already been as low as they're going to go and now coming back up. The LVRs are already at 95%. Can they go to 105? They did for a while, by the way, back in whenever that was. But realistically, those tailwinds now have not, they've not even become headwinds. They've just stopped altogether. But the things that drove the last 30, 40 years of growth, so now think about moving forward. How does a house price increase from here on? It can only increase if rates drop again, and they might at some point when the RBI has dealt with inflation, maybe a little bit, or if we earn more, any good luck with that.

44:23So think about it at a country level. Think about the property market. Ask yourself, just try and do the algebra with it. Everyone can still say, oh, well, 30 years has gone up by this much, so that's going to go up by that much. And I just did that with shares, by the way. So I'm talking about the sides of my mouth here. But ask yourself, what algebraically needs to happen for house prices to increase at a meaningful rate from here? I can't get there. I genuinely can't get to a number. We're with you, man. Yeah. Right, right. So with shares, here's the thing, right? You can go and get, you know, what can you mention about 20 % growth before?

44:57A company grows at CSL. A company grows at 20 % a year for the next five, 10 years. It does that by taking more money from more people in more markets, not just the entire Australian property market. CSL is in a small proportion of global healthcare spending, which is a small proportion of total global spending. not much has to happen i mean a lot in in csl's context but what if they find something that governments are prepared to pay a lot more for to treat a particular illness or sickness what if uh amazon manages to open a new you know um operation in a couple of countries or get to get all this man how much we probably i know five percent of american spending probably on amazon might be one percent for australia that's you know there's plenty of plenty of blue sky there think about catapult a tiny little business that's trying to be involved in more sports and more more teams and more leagues in more countries.

45:46Not much has to happen there for that to change compared to if you want more for your house, the whole market's got to grow at a certain rate. That's why I think we've kind of labored it, but the idea of source of value, source of future growth, you've got to answer that for yourself. And that, to my mind, very clearly says property is the way to go. Yeah. And just on your point of extrapolation there. So I think, I mean, you can't be too critical, right? When you look at a 30, 40 year period of a certain dynamic and go, well, history suggests dot, dot, dot. I think where you're a bit, where you can be more objective in it is, I mean, the S &P chart that you, the Vanguard chart, sorry, that you point to is 100 plus years, right?

46:29Right, right. And what you also see in that is that you have huge periods of excess, but then there was like lost decades, you know, like all the time, you know, 2000 to 2010, I believe the 70s, you know, there's just, there's big periods in that. And people did the same thing in equity markets, just like, oh, this is a terrible place to be. Look at the last 10 years. That's the long term. Nothing's happened. Look at the average return within these markets. We're very good at sort of extrapolating from what feels like reasonable long term points. But when there are these cycles that are driven structurally, and I mean by actual changes in the nature of the market, as you said, extra incomes in households, structurally lower interest rates, deregulation of banks, et cetera, et cetera.

47:18They are anomalies to what might otherwise be a quote unquote normal cycle. And it feels like a long time. I think what's also interesting, we've got to move off it. But what is also interesting is if you look at any developed world market in property over any meaningful period of time, we've actually got records in Amsterdam that go back hundreds of years. Guess what? That goes up with the price of inflation, which makes sense right like you know like that's it's pretty much what what's what's going to happen so when you have 20 years of you know seven percent compound growth or ten percent compound growth there needs to be a bit of a mean reversion in in that um i feel at least but let's talk about let's talk about shares and let's talk about yeah yeah structuring a portfolio in that context well as as we do i think that's why unusually for a podcast about shares generally or for two people who invest in shares we've spent so long talking about your initial point asset allocation because almost to your very point we and we said this before if you if you were to lag the market by two percent per year you would still do better than every other asset class historically speaking yeah and that like so that's and that's why asset allocation matters because even i mean look you can you can blow up your entire portfolio end up at zero so i don't want to say this is a worst case scenario with shares in the slightest all i mean is that's why asset allocation is so important it's why you were right to raise at the very beginning which is every dollar statistically over the last 30 years has been invested in any other asset class has cost you money compared to any dollar invested in the average return from shares now i made the point before that averages hide a lot of stuff so be careful but that's almost the point so asset allocation you know getting as much as you can in my view putting as much as you can reasonably stomach into shares is the right approach and that takes you most of the way that starts you on the 40 yard line for the 100 meter dash yes i'm just confused my metric and imperial but you know what i mean yeah uh you you you're already ahead not sure of everybody else you don't have to win this one you don't have to win at all with investing you just need to do moderately well you can finish in the top 40 of the pack and do remarkably well so but but if you start ahead by getting the asset allocation piece right and again most of our listeners probably get it because there's shares and like guys we get it we get it that's why it's important to really spend the time Come on, because we've talked before about sources of return, speaking of time and savings rate and then return.

49:34We're talking about just shares in that context, but it kind of starts with time, savings rate, then making sure you're in the right asset, then the stocks you buy and the return you get. That's where it comes from. Motley Fool Money. For more, subscribe to the free newsletter at fool.com.au forward slash listener.

49:55Let's go to those shares that you talked about, mate. The academics would say, according to the most recent research I've noticed, I can't even cite it. It's one of those you kind of go, oh, that's interesting. 25 shares is considered the right number for appropriate diversification. I want to blow that up because I want to say that 90 % of investors, just picking up numbers, misuse that stat. If you have 25 companies, you are not as diversified as the academics would suggest because the academic research suggests 25 companies chosen at random. So if you have 25 bank stocks or 25 miners or 25 IT companies or 25 retailers or 25 companies that are based in Geelong in Victoria or Omaha, Nebraska or whatever it is, none of that is diversification.

50:42So I just wanted to make that point up front. When we talk about diversification of portfolio construction, the academics don't say any 25 is fine. It is literally a case of making sure the companies that you own are either almost randomly diversified and chosen or you need to recognize that you're not diversified just because you've hit some magic number proposed by the academics. Yes. And the other point I wanted to make, it's an excellent point i've uh you know again one of the blokes i was chatting to i think he had largely lithium stocks in there you know diversification didn't really help across the lithium sector yeah exactly yeah um the other thing i'll say at odds with what you were just saying we can no it's i mean i agree but i'll it'll feel as though it's at odds which is while everything you say is true i'm pretty sure i've seen a few bits of different research that says most people who invest in shares lose.

51:45Yeah, right. So wait a second, how can two things be true at the same time that this is the best performing asset class over time and yet most people who try their hand at it don't do well? By the way, most companies, a vast bulk of companies actually underperform the index. Yeah. Even though the average is the average, most companies by number also do worse than the average. Actually, so I wrote about this recently for the Strawman members and I've mentioned this company before. No one would have heard of it or few people would have, but it's such a classic example. It's called Objective Corp.

52:17OCL is the code and it's just been a compounding machine. They do enterprise software for government largely, also enterprise customers, and they've just benefited from this whole digitization of enterprise, right, and they've just done an incredible job of compounding. There's so much I could say on it. but these kinds of companies do all the heavy lifting. And I can give you a very recent example is with the US market, the S &P 500. You take out the top seven stocks, the Apples, the Googles, et cetera. It's actually, it's gone nowhere for a long time. Seven out of 500, right? But my point is, is that that's not unusual.

52:58You've got to expect that, right? So that's why we always say either just ETF it. We get all these ETF questions. Just don't overthink it, dude. Passive, broad-based, you're away. You're good. You're going to capture the big ones. Low cost. You know, and on average, it's going to be okay. If you're going to do it yourself, though, expect the same thing. And I can tell you happily with a smile on my face of all – well, not a smile, but, you know, I can see – I don't lose any sleep over the fact that I've had all these horror stories because, of course, I'm going to. The way to think about it is – By definition.

53:31It's called the rule of five, which is for every five shares I buy, one's going to do really badly. Three are going to be mediocre and one's going to go to the moon. And that's okay. And my example with Objective Corp is actually these are very rare, right? So this thing has just grown incredibly and the multiples have gone up massively. But you could have done it with Prometicus. You could have done it with Polinovo. You could have done it with Nanasonics. You could have done it with Ordinate. You could have done it with Altium. You could have done it with – actually, there's a lot of them. And so this is actually the crux of my personal investment strategy.

54:04I go small cap. I go growth. I'm not hyper speculative in terms like they're usually, they're always businesses that have a product and established momentum out there, et cetera, et cetera, in terms of their business traction. But they were all companies that once they got going, there was such huge momentum, not in the share price, let me be clear, in the actual business there. Whereas if you bought 20 stocks and you'd only got one or two of these and the rest were just really ordinary, job done. It's not like, oh, and I think too often people look at examples and think, oh, that person just got lucky.

54:39And I think, no, not if that was actually what you're expecting, right? I can only, this is going to sound flippant, I can only lose 100%, right? But if I bought Objective Corp, I could have made 10x in very short order. In fact, I think it was, here's another little interesting example which helps you think about it. In 2015, shares were at$2, right? And that had been 10X over the last three years. It had gone from 20 cents to$2, right? Wow, that's pretty good. And actually, it's gone up a hell of a lot. Now it's$13 today, right? And these are the ones that you know are incredibly hard to find.

55:27You know that they are rare. You know that they're exception to the rule. But rather than try and think about, well, this is where investors, I think, bail out too quickly. They buy a basket of shares. A couple of them are really battling a stuff this for a joke. I'm out, right? Not knowing it. Actually, no, no, that's normal. That's what you expect. The mistakes are when you double down on the bad ones and you take profits and you trim the good ones, you know, you weed the flowers and water the weeds kind of thing. But I think these stories sort of, for me, sort of show that, yeah, I want to be diversified and to your very exact point that, yes, not just all where I have highly what they call correlated risks.

56:12but I want to spread it around in such a sense that I only need to capture a couple of these baby giants, a couple of these monsters, you know, that are just, and then everything will be okay within that. And that for me is more of why I think you sort of start with a decent spread. We can get onto sort of how you manage positions and stuff sort of over time, but I wanted to put out there because it's, this is not a game of strike rate. This is a game of averages. So I want to provide the counterpoint to that just to flesh out that thought because it's only not a game of strike rate if, well, your point is valid by definition.

56:58The strike rate is irrelevant. But the companies you're investing in and their likely spread of returns does determine what strike rate you need to get the average you're looking for, which is not in any way disagree with what you said. I just want to flesh that out because if you're buying Woolies, West Farmers, Coles, CBA, Telstra, whatever, that can be fine as long as you pay a good enough price. But you need nine out of 10 of those to go well for you because the upsides are so limited by the fact they're already massive. Trees don't grow to the store. These are big red ones, right? Strong agree.

57:31They're 300-year-old, 600-year-old gum trees. They're not getting any bigger. or maybe they'll get very, very, very slightly bigger, very, very slowly. So you need to get nine out of 10 of those right because if you overpay for six or seven of those, you've almost consigned yourself to fine performance, frankly. It's not even disastrous, right? You'll be completely fine. Woolies will keep growing. CSL will keep growing. Telstra will keep going, whatever, whatever. Over time, these companies will be completely fine. You won't miss having bought them, but the size of those returns, and frankly, there are some.

58:01Look at banks over the last five years. you've overpaid probably five years ago now if you bought them two years ago or a year ago or today different thing because we're looking at backwards rather than looking forwards if you're buying stuff and you're saying i'm going to buy 20 that are 100 bagger opportunities only one of them works you still might have squillion bucks yes and so it you know the average is all that matters by definition doesn't matter how you get it but you need to know the game you're playing otherwise you run the risk of taking the wrong approach you know if you if you buy if you buy the blue chips trying to get trying to follow andrew's lead and not care about the strike great you don't yourself a disservice i'm so glad you mentioned that yes if you buy not not yeah if you want nine out of ten from the stock for andrew's buying you will give up and say you know stuff this for a game of soldiers i'm out yeah so there is there is definitely that that return yep mate um i want to i want to ask you about that so your style is slightly different than my side i also i like growing companies as well i don't buy as many small caps as you and i don't i don't have as many moonshot potential opportunities as you do uh i'm probably in the mid-capish shutter space on average with a couple of ETFs and some solpats and stuff just thrown in.

59:07I want to ask you about the way you think about your portfolio from that perspective, because what you just described, there will be some people listening who said, hang on, that's exactly what I said I was doing in 2020, 2021. And my portfolio was a mess. I'm down 80%. All those stocks that were supposed to be the best things ever have just crashed and burned. the new x's the whispers the uh dubbers the pick some names here right the stuff that flew arguably too close to the moon or too close to the sun should say and and have come crashing back to earth people would have said well hang on that's exactly the approach i took two three four years ago and look what's happened to me page you're talking rubbish uh that doesn't work look how much money i've lost uh how did so so how do you think about constructing a portfolio when And the very strategy you're talking about, people will say, I tried that.

59:57It didn't work. That's fundamentally not a winning strategy. How do you respond to that? How was your portfolio different to that? What are you looking for in that context? I mean, I try to be as informed by history as I can here. And I think too often people rule on the viability of things too quickly. I mean, if you do something, anything over a couple-year period on the market, there's no validity to that whatsoever. Anything could happen. It's luck, really, those kinds of timescales. So if you kind of thought, that sounded good. I'm doing that a year later. I'm down 80%. This is all rubbish.

1:00:33I was like, well, where did you read that you have to just do this over a 12-month period? Like, that's nonsense, right? And so what does history tell you about these objective corps, these Pro Medicuses, these Nanasonics, these kinds of company? they're always expensive. They're super volatile. They spend very long periods going against the market and falling down. You have all this temptation to quote unquote lock in profits along the way. I mean, you bought shares at Objective Corp in 2015 at two bucks. Did you sell at three to at four? Incredible profits at any point in time. Stupid thing to do.

1:01:14So what What do you – I think it's about going in with very clear expectations and also understanding what it is – these things do not happen overnight. You cannot force the petals of a flower to bloom, Scott. You can only nurture it and give it time, right? It varies then of you. They'll be on a greeting card one day or, you know. I probably stole it off a Hallmark card. But it is really, really important to grasp that. And for me, it's also important to remember that none of this is set in stone. I can hang up from you right now and completely reorder things in 10 minutes. Click, click, click, click, click.

1:01:59Hopefully, it takes me longer than that to really think it through. But mechanically, it doesn't take long. So I think you – sorry, I'm being all over the place here. One, you've got to give it time. Two, you've got to be very clear in recognizing when something is clearly busted, not because the share price is down, but because your expectations for the business are just way off the mark. I expected this company to grow at high double-digit rates for many, many years, and it's going backwards. It's broken, right? Whatever the market says that I was wrong and I'm out. And so you have that discipline to sort of do that.

1:02:31You have the discipline to resist selling businesses that are on that J curve that are getting incredible sort of traction. And then you're not pivoting because you're trying to be too clever and restructure and reweight and everything along the way. But you're just making sure that does the business, is the business still performing to my expectation? Is the price reasonably sensible given to a future sort of outlook? If so, then I probably don't need to change anything whatsoever. And so you're just constantly making guesses at various points in time, but you get to course correct. You get to course correct all of the time.

1:03:10And that does require really deeply understanding your businesses. It does require sort of keeping up to date. It doesn't mean standing in front of 12 screens, you know, like a lot of those idiots do. It just means making sure when a company has an announcement or it releases its half yearly or full yearly, you read the damn thing because you've got an investment in it, right? and and and you and i i guess but it really just does come down to expectation i really want to be clear here this is not what i'm i'm advocating that everyone should do this just that i have i do it this way i do it because i feel as though it's a it's a it's a pretty good process relative to my circumstances relative to my temperament relative to my outlook but the decision is sort of set by the context in which i sort of set all of that up and and that's that's just really important to know i think before you do anything it's just sort of like too often it's just like i'm investing in shares like we're all doing the same thing you know there's a hundred different ways to skin a cat some are better than others and some are better than others for different people in different times but but you've got to know where you're you're sort of starting from and what is a reasonable expectation there and i i take a lot of inspiration from david gardner one of the founders of the fool right he's got an awful strike rate he's got you know you don't I'm not speaking out of school here.

1:04:24He talks about it all the time, right? Oh, totally. Three out of 10, right? Something like that, you know? He says partly proudly, partly humbly, kind of, you know, self-deprecatingly, he has more losers than anybody else at the monthly four. Oh, yeah. More losing stock picks than anybody else at the monthly four. And you see the, oh, another one, got it wrong. It's like, look at the long-term average returns there. And what did he do? And not because he's clear in what he is trying to do. And when you're clear with that, the expectations become very obvious. So when something doesn't work out, this wasn't a surprise.

1:05:01In fact, I didn't know if I necessarily expected it with that company, but I expect it with a very high percentage of my companies that that is going to be the case. This is normal. This is what I'm expecting. so i want to try in as we kind of get towards the end of the podcast to give people something to take away specifically because we've done lots of it depends you've got to know yourself all that kind of stuff and that's very again very zen very very can't force flowers to bloom i can i say when talking about flowers blooming i can't help but think of bob cadder's famous um you know let a thousand flowers a thousand flowers bloom for all i care exactly look it up on youtube it's it's just the way he delivers it is spectacular anyway um the i'm mindful that lots of it depends do you you all that kind of stuff which plenty of listeners thinking fine but what do i actually do with that how do i how do i put that into practice yeah so i'm gonna i'm gonna start with my thoughts mate i'm going to then ask you for yours yep i think it makes sense for me personally to try to find my best ideas because it makes sense to come up with your best ideas.

1:06:12And I will say to people, the more confident you are, and I want to be really clear with that being condescending, the more reason you have to be confident, in other words, I don't talk about arrogance here, I'm talking about genuine confidence, earned confidence, justified confidence. The more confident you are in your approach, in your track record, in your ability, not just because the market went up so everything went up, but genuine ability to analyze businesses, to understand pricing, to buy at good valuations, the more concentrated you can afford to be. The less certain you are about your ability to do that, the more diversified, the less concentrated, the broader, choose your term, you should be.

1:06:54So that's my first piece of general advice for our listeners is start broad and then narrow down. because there's just, you know, if you're 18, you've probably got that much life experience. You've probably not been investing before. You're just starting out. Do you think you can pick the five companies you're going to do best? Probably not a great starting point, unless you're Warren Buffett. Or if you're Buffett, knock yourself out. I'm not, you're not, most of our listeners aren't. Warren, if you're listening, g'day, thanks for listening. But broadly speaking, I would suggest that the less experienced, the less justified confidence you have in your ability, the more diversified you should be.

1:07:29Now, that doesn't mean you just have lots of companies. You just put a decent chunk of your portfolio in ETFs. You can have one ETF and then five, seven, ten other companies because if that ETF is 20%, 30%, 40 % of your portfolio, that takes care of most of the diversification for you. So we say number of companies. ETFs have turned that on its head because if you have an ETF that's half your portfolio, you can have one other company, two other companies, three other companies, and most of the diversification is done by the ETF already. You could have 90 % in a broad-based ETF, right? Exactly.

1:07:58Yeah, exactly. So that would be my first starting point is the less reason you have to believe you are going to necessarily beat the market, the more diversified you should. Can I interrupt very quickly? Please. What I would say there is don't feel as though you're taking a huge compromise there either. Yes, that's a good point. I heard this really great podcast a little while ago. I forget which one it was, but Morgan Housel was the guest. Right. Former colleague of ours in the US, Motley Fool. Excellent writer. Works for the Collaborative Fund. I just buy his book. I get no kickback from it, but I can highly recommend it.

1:08:34It's like College of Money. Yeah, he's just such a great writer. I hate him because he's so good at writing, by the way. He has my eternal – other young people, I hate good writers. They're the people I wish I could be, but go on. Good writing is hard. He invests all his money in ETFs, and he's right deep in the space, right? And he was sort of saying, oh, my friends are like, why would you do that for? You could do this. And he's like, you're all assuming that I'm not doing well. Yeah, right, right, right. You're assuming that I'm making this huge, you know, I'm giving up all of these untold riches.

1:09:07Like, actually, I'm doing just fine because markets tend to do just fine. So, you know, that is just a point worth making there is that you're absolutely right. Be honest in your confidence, in your ability and the rest of it. start off with those things but it's not like you're really just like oh i'm missing out on all these potential untold gains if i only did it myself not necessarily yeah that's a great point my second offering mate is to think about diversification in a more nuanced way which doesn't mean it's difficult just means you have to put your thinking cap on to the way people would talk about it right you you know for lithium miners is not diversification for banks is not diversification.

1:09:47But equally, a bank and a retailer aren't as diversified as you think either because they're both reliant on economic activity and consumer incomes and the confidence or strength of an economy. So think about businesses in the context of the factors that will make them successful or unsuccessful and really do that. Don't think about the quotes industry. Can I tell there's nothing tech is cisco plus amazon plus apple plus afterpay now if you think those four businesses are even close to the same or even meaningfully interrelated i've got another i've got another message for you right they're just they're very they're all tech in quotes they're not very useful um same with consumer discretionary the same with other stuff i mean solpats is apparently an insurance company because it has some industrials i think berkshire's officially an insurance company i mean realistically you know if i owned qb and berkshire hathaway i'm pretty okay with that.

1:10:43I don't know if QBE, I'd sell it. But you know what I mean? So think about the exposure of your portfolio to the same number of risk factors. And again, like the piece I just mentioned before, the more reason you have to be confident, the less absolute diversification you can afford. And the more you should be just, well, again, the less experienced, the less confident you are, the more diversification you'd have. Think about where things are impacting your companies. Because if you get a big factor wrong, then you may cause yourself some grief. The last one is the longer term your focus and genuine focus, not I wish I was long-term, but I can genuinely afford to say I've got a 10, 15, 20, 30, 40-year time horizon, the more you can afford to wear the slings and arrows.

1:11:29Back to the asset allocation thing. If you're in retirement, you need some money, either have it coming from dividends or have some cash set aside. Don't rely on share prices being what they are in 12 months' time. to be able to fund the lifestyle you've got. So they're probably my key portfolio recommendations or suggestions as you think about what's right for you in terms of portfolio construction. I would be in your invested assets, still 100 % shares. But if I was 69 and I needed a certain amount of money to live and I was investing in growth shares, for example, I would have a decent amount of cash on the sidelines, probably two or three years living expenses.

1:12:07Because like the last couple of years have shown, if you bought in 2021 and then spent two years just going backwards at a rate of knots, you don't want to be selling if you think the shares are too cheap to sell. You want to be able to have some of that cash on the sidelines. So think about where you are in your life as well. What tips, what hints, what suggestions would you give our listeners, Ram? Yeah. I mean, people really want a, and you understand why, right? We all do. You want specifics, you want a formula, you want an approach, just do this and you'll be fine. 30 % equities, do this, within that, do 10 stocks, make sure of this and that, boom, boom, boom, tick all the boxes and you'll be fine.

1:12:41It doesn't exist. I don't really apologize for all of the it depends and maybes. Oh, totally. Yeah, yeah, yeah. It's why we have financial planners, right? Because it does depend. I would just say in your analysis of your skill, it's very hard not to let the ego get in the way. I've said before that the most dangerous start any investor can have is to start investing in a bull market where everything you touch goes to gold. You know, just off to the moon. I'm a genius and can last for years. And you think, well, I started off prudently and sensibly. I put most of it into an ETF and I started picking shares.

1:13:19The ETF went up 8%. My portfolio of shares over the last two years up 50%. I'm going to go, I'm going to do this full time, right? And it just, there can often be that pride before fall moment. And I speak from experience here as well. You know, the periods where you really feel like a master of the universe is just really dangerous. And so in your reflections, I do think it's a very valuable exercise every year or so just to sort of look back and go, well, what happened and why? You know, was it the realization of an investment thesis? Or did Philip Lowe cut interest rates by 4 % and the entire equity market went up?

1:14:00I mean, you'll take the gain. don't want something you don't you've just that's why you always stay invested because you can't predict these things and you know they you know they're gonna throw things around but you you kind of got to have the good times in there to sort of make up for the bad time that's why you just stay invested right so it's all good but but but really reflect honestly on where are you the genius that you think you are and everyone knows you are or were you right place right time for that particular thing and that's a very hard thing to do and i a lot of soul searching for me always trying to sort of figure that out for the ones that went really well and for the ones that went really bad as well.

1:14:34So it's a very difficult process. I think for a lot of people, particularly those of us with a Y chromosome,

1:14:47you love the – how do I say this? There is something where men just love the speculative dimension to it. You know, we do, right? It's a lot of fun. We all feel as though we are Warren Buffett and we can kind of do it. I mean, this is the great thing with the liquidity and the fractionalization of the equity market is that you can kind of have your cake and eat it too. So have some fun. Look, honestly, if you want to buy super speculative, early-stage mining prospecting company, knock yourself out. I'm not going to tell you not to do it. I'm going to tell you not to put – I'm going to tell you not to do it.

1:15:23Well, look, let me put it in context. like if you're gonna put 20 % of your money into it be careful if you've got 95 % of your money into a low-cost passive index tracking ETF and this this allows you to scratch that itch feel as though you get the the the wins when they happen and you know it it's going to be a wonderful it's going to keep you in check it's going to save you from yourself to some extent that's also true you can do that right you can you can have if you've got the urge quarantine it yeah just It's quarantine. It's like having a sports bet account off on the side. Hopefully no one realized you're going to make any money off that.

1:16:00But if that gives you a bit of joy and more importantly, if it stops you doing stupid things, then that is, you'll have my full endorsement. You'll have my full endorsement for that. There you go. Quote, Andrew Page endorses sports bet accounts. I don't, by the way. No way. You just said that. I'll selectively quote that before you later. So, mate, that is, I hope our listeners have really enjoyed a bit of a dive into how to think about portfolios. We've covered a lot of ground. We spent a lot of time on asset allocation because, again, I think that's the most valuable part. If you get a roughly average share market response or result, you're going to be better than almost every other asset class over the long term is my strong view, certainly been the case in the past.

1:16:42I've seen a reason for that to change. So that was important. And then just some ideas about how to think about when and how to diversify how to construct your portfolio, how to think about strike rates and averages. There's probably, that's probably the most important thing I'm going to just ask our listeners to remember is, it's not about the strike rate, but you have to know the game you're playing. You really have to know the game you're playing. Because if you, you know, if you think the strike rate doesn't matter, but you're not going to get the average you're looking for, then it does. And it is genuinely the, it's the strike rate times the average return per stock.

1:17:13That gives you the total average. That's how the maths works. So we don't do a lot of algebra on the podcast, but thinking through that idea, I hope has eliminated a lot for a lot of our listeners. Any parting thoughts, mate? Just stay humble. Remember that it is a lifelong process. I mean, I don't care if you're 80 or 90. If you're not learning or at least reflecting and adapting and growing as an investor, something's wrong. So it is not ever anything that you just, oh, I've got it now, I'm fine. Like it will always be a learning experience. And as I say, stay humble, keep learning, be open-minded, be honest with yourself.

1:17:51And I think it just gives you a good foundation to work from. Nice. All I'm going to add, I mentioned halfway through, but in different contexts, keep dollar cost averaging as well. Well, that's the other free kick in investing. Right. There is so much that comes down to circumstance simply by doing it over time in small, regular increments. You really do take out a lot of the stuff that's, you won't change the volatility of the market, but you get the opportunity to, frankly, when shares are more expensive, you buy fewer of them. when they're cheap, you buy more of them. It just weights things in your favor.

1:18:21So do what Andrew says. And also dollar cost. Can I give you a crazy example of that I heard the other day? And it's not to segue into one of my favorite topics, but even if you'd started investing in Bitcoin at the peak, right? It's 69 ,000 US. You're in profit today if you just dollar cost averaged. Like I think it was every week. Oh, there you go. That's cool. And I just say that because it's an extremely volatile asset that's well down off its peak. But you will find this, whether we're talking about CSL or objective corporate or anything like that, it is just such a guaranteed, it's not as good as picking the bottom and selling it.

1:18:54Obviously, but it is, but it, but it, but it really, and it just takes it away. It just takes all of that structure and timing stuff away. Focus your time and energy on, on being the most productive person that you can earning money in a way that is enjoyable to you, saving, you know, not spending it all and saving some, and then just regularly kicking it in. It's so simple. In fact, it's too simple that people feel as though they need to complicate things. But really, if you do nothing other than that, I won't guarantee it because you can't in this game, but it's about as close to a guarantee as you can get.

1:19:30Whether it's market beating or very satisfactory, wealth-creating, long-term returns, passive ETF, regular dollar cost averaging, job done. Job done. And on that, Fool on. Cheers. The Motley Fool and people appearing in this program may have positions in the companies mentioned. General advice only. Please speak to your financial professional to understand how it may pertain to your situation. Subscribe to the free newsletter at fool.com.au forward slash listener. The Motley Fool operates under financial services license 400691.