Accidental Indexing: Why Owning Too Many Stocks Destroys Returns

0:00We look at our brokerage account, right? And if you're like a lot of people that I know, you're going to see 35 different stocks. And to that, I say congratulations. And I don't mean to sound mean, but you've effectively or ineffectively created your own index fund. A lot of investors, we spend our time just trying to find that perfect stock. And we don't spend a whole lot of time figuring out how big of a portion we need to take of that certain stock when we find it. So today, hopefully that's going to change. So buckle up. Here we go. I remember starting my first business. I had no clue what I was doing.

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2:34Your path to financial freedom. Start now. And welcome back to the Investing for Beginners podcast. My name is Stephen Morris, and today I have my in-house therapist with me, all things psychology, Andrew Sather, and he is going to help me work through why my brain tries to buy just a gazillion shares of that perfect stock I find and completely ignore what that gazillion shares is going to do to my portfolio. uh so i guess i guess andrew i'm sorry i'm let me back up hi andrew how are you hi take a seat please you're gonna be a tough one to crack i can tell already so did you get your you got your timer started so we don't go over on time and everything exactly um so andrew i guess the the first question i have is why do you think it is that we struggle so hard?

3:40Like when we find that stock, and I know you do it too, but you find that stock and you're just like, oh, I want all of it, give me all of it. And like what it's going to do to our portfolio in the long run is like the furthest thing from our mind. Is it like shiny object syndrome? Like what is it? Yeah, I think it's a little bit of everything. Definitely shiny object syndrome. And if you've been doing this long enough, I think some of it too is understanding you do need a decent size to make an impact with your positions. You know, I've been running the Value Spotlight portfolio since 2014. And I've definitely had my share of stocks, Costco being the one I always bring up because it's the most painful.

4:26But these stocks where I just buy a tiny bit and they do really well. and I look at my overall portfolio and I was like, it doesn't make a difference whether the stock's in my portfolio or not. It was so small when I bought it. I didn't buy hardly any shares. And so even if it doubles or does whatever, you don't really get the impact. So some of it I think is good nature. Like it's a good philosophy, but like a lot of things emotional in the stock market, you can definitely take it way too far. and I know for me personally I definitely took this too far several times and it really wrecked my my performance um I think tracking your performance is probably a good thing kind of like the the AR mentality like you mentioned but man that really makes you realize when you make a mistake and making big mistakes when you buy too many shares of something is a great way to make a mistake that not only hurts, but also takes a really long time to come back from.

5:33And so I've had to deal with years of trailing the market because of a couple bad decisions. And that, I mean, if you're not tracking your performance, who cares? But like, if you are, that is not a nice feeling. It's really not. And, you know, as you were talking, I was sitting there thinking, he's like, well, maybe it's not so bad because that's how I learned. You know, I had a commander back in the day. He told me that.

6:04That there are two ways that human beings learn, and I'm the latter. And I said, what do you mean by that, sir? And he said, you learn by blunt force trauma only. And so he never told me what the other way was. I just know I learned by blunt force trauma. In other words, it's got to get beat into my brain. And so I was thinking about like how I learned. And like, obviously, I like to do things the hard way and I learn best from pain. I think a lot of us are like that. You know, we you know, we do something that hurts. It's like, oh, don't do that again. Let's try this instead. But like you but then you finish that off with it took years to recover from.

6:46And in some case, you know, some people are probably still trying to recover from. And so maybe blunt force trauma in this case is not the best route to take. yeah absolutely do you find yourself more tempted for certain stocks than others or is it just anything that that like looks really really exciting like i'd love to walk through doesn't you don't have to tell us the exact company but maybe where your mindset goes and what are the things you were thinking of that compel you to want to buy a lot of shares well i'll talk about one that we've already talked about a lot that everyone knows i own which is cat um and why got me so excited about it was just like how we've talked about you know ai doesn't have to be a straight ai play um so they're they're they're the work they're doing to help with ai and stuff like that that got me really excited plus like the automated um uh side of things so um just a lot And the structure of the company and the safety that they've built into it.

7:58So we talk about margin of safety, obviously, a lot on this show. And they've intentionally built margins of safety all throughout their business model to protect them from downturns in the farming industry, the construction industry, all these things. so yeah they'll feel the hit on the bottom line but it's not going to unless it all goes wrong at one time they're not going to feel or it's not going to bankrupt the company and they'll be able to recover and you know if if the worst happens then owning cat is going to be the least of my worries so you know um but i i think those were the two biggest factors that got me the most excited for Cat was their moat, ultimately their moat and their diversification into AI.

8:46So something I'm hearing from you saying that is you're kind of getting the best of both worlds. You're getting a company that's generally conservative, but also getting a lot of the upside of AI. So you're getting conservatism plus growth. And when I look back at my biggest mistakes, which makes me look at some of the, some of the decisions I've made most recently and the stocks I'm gravitated towards today. Um, that's always for me, like value and growth, like that rare combination where it seems like you're getting a deal that's almost too good to be true. Um, from my experience, those have been the stocks that I'm most, because like you, like I'm risk, more risk averse.

9:32I don't like the idea of just throwing it all on whatever is growing the fastest. And so to be able to think I can get fast growth plus a conservative company that has, or conservative the price, if you're looking at the valuation, that's such an appealing and emotionally grabbing. I don't know why that's so emotionally grabbing, but to me, it just, I start seeing, you know, just the brightest of futures when I think of that. and I think so with cat you're 100 right like they show just massive amounts of room for growth and innovation I I like to use the word innovation rather than growth um but the same thing I guess so I mean it's plus like I said it's a it's a safe play and it's funny you talk about risk being risk adverse so when i started i was not because i thought the market was about making money quickly and if you're day trading that's kind of what it's about you're making money as fast as you can and dipping um so i mean that was my mindset and then when i got you know when I met you and started learning this it became hey like this is this is the path to wealth and the guy you interviewed a couple episodes ago I can't remember his name he said something that really stood out to me and I actually fact-checked him on it because I didn't think he was right but he said there are no billionaire traders and he's right I couldn't find one.

11:11There are a lot of extremely wealthy traders, but no billionaires. And I was like, that's pretty cool. And if there are any out there, I couldn't find them. My Google food is pretty strong. So if you guys find one, shoot them to me, let me know. But regardless of whether there is one or not, even if there is a few, they're, you know, compared to how many billionaire investors there are it doesn't even scratch the surface you know and that that really struck me and that's kind of the mindset i adopted when i started working with you is this isn't about me making money quick it's about making money that lasts over time and that mindset shift it really was uncomfortable at first trying to manage like okay now i need to be risk adverse versus risk tolerant and it was hard and but now you know it's like drinking water it's just right you know it's right there in the brain but it's just you saying that made me think i've never really thought about that before um but yeah like that that definitely plays a big part in it of like, you know, you got married.

12:38It's like, can I see myself with my wife in five years, 10 years, 20 years? Like, that's a pretty important question to ask yourself before you get married, right? So it's like, why don't we need to do the same thing with our stocks? Can I see myself owning the stock in five, 10, 15, 20 years? Yeah, that's a perfect way to think about it. I really like that. Do you, do you see yourself as being a little more risk tolerant when you start thinking about buying a bunch of shares of a single company? It depends on what it is. Um, so, you know, we've talked about beta, um, which thank you. If I, if I haven't said it recently, thank you for talking me out of buying that stock.

13:25Um, a really cool company, not a great stock to own right now um but like with beta i was totally risk tolerant because i thought it was so cool and i was willing to tolerate that risk uh just literally just because i thought what they're doing is cool um fortunately you showed me showed me the air of that and i think that's a great example of the difference between being risk and the and and the investing space the difference between being risk tolerant versus risk adverse um because you know being risk tolerant in that case would have totally screwed me up um and like i said thanks for talking me out of it um and it's funny because andrew didn't even really talk me out of it he's like yeah it's cool and it's like oh like that's Andrew for this this stock is not good um that was him talking me out of it but uh but no seriously it made me it made me go back rethink things and then suddenly I realized that you know the error in my logic and that stopped me from making a huge mistake and with that said because i was so excited about just what they're doing and the space they're trying to create um because let's like the space they're trying to create doesn't exist in the market right now and that is super cool and it's like it would i would love to be on the ground floor or something like that but there's just so many risks okay that are you know and And to their investors, when that company takes off or a company like it takes off, no pun intended, it's going to make them a crap ton of money.

15:28And good on them. They can tolerate that risk. And for them, it's not risk tolerance. They're still being risk averse. They just have the capital to do so. And I'm not in that space right now. So I think that's another big factor of it. and I will stop rambling after I say this, is how much money do you actually have to invest? If you only have$100,$150,$200 a month to invest, I think you should probably be very risk adverse because you don't have a lot of room to play with. If you got millions upon millions of dollars that you can just throw out all willy-nilly, how you see fit, then yeah you can go you can go play with a company like beta and that's cool it's not going to hurt you um so yeah i think i think those are probably some of the bigger factors that played into it for me bitcoin is one of those really divisive topics and depending on where you stand on it either you ignore it or you can see its future utility and the things it powers and so in a time like today we're all wondering how much exposure makes sense and how can I get that exposure in a simple and easy way?

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19:49optional subscriptions to found plus for$35 a month or$315 per year or found pro for$80 a month or$720 a year there are no monthly account maintenance fees but other fees such as transactional fees for wires instant transfers and atm apply read found fee schedule i really like the advice you give of this idea like if you don't have a lot try to be more risk averse because i think that's something the portfolio that you've seen on value spotlight has shown is that um you can you can build the portfolio slowly and steadily and then once once it hits a decent size now you can take those bigger swings and so like let's take an example of let's say you found the next netflix very early on like it was one of the first stocks you ever bought that's cool like you made let's say you made like a hundred bagger on, on your first investment, 150 bucks, not necessarily going to change your life, but imagine you had built up a portfolio slowly and steadily over time.

21:01And now maybe you're able to put$2 ,000 into finding the next Netflix or whatever that number is, that could be so much more impactful for you. Um, and so I actually find myself being a little more risk tolerant now. That's like the portfolio is at a decent size where I think I can throw money that I could see more being life changing. Whereas in the beginning, even if it was like a hundred bucks, that's still not going to change your life. Even if it's, you know, a top, top, top performer. And then there's Nvidia and that, that, that stock would have changed anybody's life if you held any of it.

21:40But other than that, even the top performers, if you're not starting with a lot. And so I think it's powerful to be risk averse because then you can kind of build up and slowly over time and be in a more sustainable place versus like if you're trying to build, but you keep throwing money away on these speculative moonshots and you keep losing money, losing money, losing money, you're really not making any progress. And I can imagine that would be quite discouraging. And so maybe there is something to being risk averse as a beginner. I think so because, you know, I've talked about, you know, my dad, I don't even know what I was trying to say there.

22:23My dad, back in the day when I was younger, kind of compared the stock market, unless you were wealthy, to gambling. And I think if you are not, if you're being risked, very risk tolerant in the beginning when you don't have a lot of money to invest, that's pretty much what you're doing. with the ultimate exception being you're probably not going to lose all your money but you do it enough times you will and you'll definitely even if you don't you'll definitely impact your ability to make more money so I think being risk adverse in the beginning because that that takes that gamble away from it and now you're making a logical a very logical decision that you can get behind and and you know people say can say well why do you own this uh you know whether it's cad or uh zotus or or what other have we talked uh oh costco people you know people can say why do you own costco i can i can defend costco till the day i die and you know it's not bs like it's it's the real facts and people can can say why they don't and those are real facts too and that's fine but being risk adverse in the beginning has is what taught me to be able to do that to be able to stand stand my ground on a thesis and say this is why i believe in this company these are the facts that i'm looking at yes you got a point over there on your side but i'm sticking with mine um versus if you're just being totally risk tolerant um you know why why did you buy beta well i mean it's cool like they're building you know air like uh electric airplanes and a lot of them are for personal use like you don't even need a pilot's license how cool is that like um but then there are just so many arguments like yeah can you imagine the legislation that's about to come down on this stuff like they're about to regulate the crap out of it like and then like what is that going to do to their their bottom line um so i mean i think all like what you said i really like you know being risk adverse in the beginning is definitely the way to start i think uh versus just let's let's see what what you know a thousand bucks in a company we think is the next nvidia is going to do for us yeah absolutely Absolutely.

24:58So I guess in your mind, because everybody's portfolio is a little bit different, but how does structuring a portfolio, structuring the sizes in your mind, what does that look like for a more risk averse way versus a more risk tolerant way? And like for beginners, maybe give some reference points on how they can structure their position sizing. So it's more on the risk averse side rather than the risk tolerant side. yeah so when when i started i had you guys help me with the valuations of companies um you know uh trying to think uh coke um home drama spotify um companies like that um that i wanted to own and spotify we talked about like I own Spotify simply because I love Spotify so much.

25:54I'm their ride or die no matter what. They go bankrupt. I'm going that way. Not really, but I just love that company. So those are companies like that that I was able to get a good size of with a good valuation. Amazon, Google, or Alphabet. these companies make up the majority of my portfolio. And the way I've been doing it, so now that I'm comfortable, we'll use Cat or Zotus as the example. I sized down some of those shares so that I could make up the difference in the companies I wanted to buy. um and so now i sit at 11 companies in my portfolio um and i don't think i wanted to ever get any bigger i think i think 11's too many i think i wanted to keep it at 10 um but you know i got greedy i guess and i i added that one more but that's the hard line like i am not going to add another i don't care if if that's the case i have to sell something um which that opens up a whole different can of worms on trying to figure out what to sell.

27:19But that's ultimately how I've done it is at the very beginning, you know, the core companies of my portfolio made up the entire portfolio. And as I've done my work and my research and things, those position sizes shrink while the others have grown. yeah totally makes sense and if your dollar cost averaging that's how it's going to look anyway so whether you do it kind of like on a big chunk and then work your way over time or you're doing it starting from dollar cost averaging from scratch it's going to look similar um yeah i like that i like that a lot yeah ultimately when i started it was a big chunk um merging several different accounts um and like i i understand the whole argument of dollar cost averaging that's fine um and i agree with it actually it's just at the time i it was more of just me being lazy than anything i just i wanted it started i wanted to know exactly where my money what it was so that i could start going the other directions that i wanted to go um eventually um so i guess in the long grand long-term grand scheme of things that wouldn't have really mattered um i i guess i should do the math and see which one would have paid more i i don't see it being a huge difference though um but yeah so ultimately ultimately that that's that was the decision i made but I do agree with dollar cost averaging 100%.

29:03I just think there are certain circumstances where lump sum make a little bit more sense. Yeah, totally. Everybody's journey is different and so everybody needs to, just because Andrew does things one way or Steven does things one way doesn't mean that your personal finances line up that exact way every single time. So it's cool to hear the way you approached it and the way you sounded like you had built it over time as well. So it wasn't like, that's another thing investors can do sometimes and just panic and be like, I want to be fully allocated and everything I want tomorrow. You know, and that can have all of its own problems.

29:44And so you did, you took the time, you did the research, you got comfortable and you can defend why this company earns, deserves its spot in your portfolio. And so if tough times do happen, and I'm sure you've seen the stocks don't all move the exact same way every single day. So as the tough times come, you can understand, you know, I've already done the work on this company. I'm ready to stick through it unless something crazy happens. I mean, we just talked about one recently. It's been probably about six months or so, but Costco was facing some serious backlash. um possible legal issues with some of their their their branding stuff and some of some of the stuff that going on and i was really concerned as much as i love costco i was like man like this this does not look good but ultimately you know after talking it over with you guys it ended up becoming you know just well let's just see what happens and you know true true to true to fashion it washed out and you know everything's fine again ish um still recovering a little bit but not as bad as it was um so i mean like that that's definitely the case and i i would say it probably took me a year um to get everything flushed out maybe a little bit longer to get everything flushed out to exactly the way i wanted it but also keep in mind if you're listening and you're like you know a year like i do this for four hours every every saturday like this was my full-time job like this is what i was doing all you know every day and i have other stuff i have to do of course but like that that was a big portion of my job but what i was doing so i had the time um if you are just you know doing it as a hobby or for retirement whatever and you only have a few set hours every week it may take you a couple years and that's okay that is perfectly fine um i i hate the especially social media social media is the worst like oh you got to get in on this before you miss out you know what the beautiful thing about the stock market is yeah yeah i missed nvidia but here in a couple years there will be another one maybe not nvidia but there will be another nvidia sometime you know complete it might be ai it might be electric cars it might be something like who knows some new market completely but there will be another big company and people are going to be like how is this possible it blows my mind never seen anything like it.

32:31Like how many times have we said that about a stock in the stock market? Like a lot. So don't let social media freak you out into thinking, oh, you got to get on the ground floor of this stock right now because it's a lie. It's a really big lie. Frustrates the crap out. I hate social media so much.

32:58So I think one of the biggest struggles I had in the very beginning, Andrew, is we all know Warren Buffett famously had a very tiny portfolio. So I mean, in your eyes, I guess, what is the difference between, I would call what he did concentration versus of diversification and i'm with before you answer like i think just talking to people like people in value spotlight or listeners like people think of diversification as like i said in the in the opening like basically being a index fund like you have 30 stocks and i i think that that is not diversification at all. I think that is just going crazy.

33:46I could be wrong. I'm just curious on your thoughts on all that. This episode is brought to you by Facebook. So you were scrolling on Marketplace and there it was, the bike you'd been searching for. You sent a message and it turned out the seller was super chatty, kind of funny, and an avid cyclist. The next thing you know you're in a cycling crew, well, a community cycling group. The thing about Facebook, you might find more than what you're looking for. From a browse to a bike ride, this summer, find more on Facebook. This episode is brought to you by Starbucks. That is fire. Whoa, that's good.

34:27This might be the drink of the summer. Okay, I like this one too. I'm rocking with it. Okay. Try it for yourself. Starbucks refreshers concentrates are coming home. Find them in the coffee aisle and make it yours. Yeah. I mean, this idea of having a core portfolio, something you can kind of hear people talk about, and then just having these little baby positions. And I like that. And if I look at my portfolio, and this is something I show to subscribers of Valley Spotlight, my top 15 stocks make up 89 % of my portfolio. And then I have, I guess, 10 or 11 that make up the rest that are so small, they're almost inconsequential.

35:14So that core portfolio, and again, some people like 10, a lot of research has talked about 15 to 20. somewhere along there, you're still, if one of the stocks in there does really, really well, that's still going to help your portfolio and give you enough of an advantage compared to just buying an index fund. But once you start getting to 25, even 30, 35, just think of the math on like a 25 portfolio or, or yeah, just just 25, just to make it easy. Uh, if you had 25 stocks evenly, that would be 4 % per stock. And so, um, you know, if, if your, if your stock doubled, it would only help your portfolio by 4%.

36:09So that's not, that's not super helpful. And when I think of a portfolio, I don't necessarily think that it needs to be all even like, okay, I have my 15 names and they're all perfectly manicured, like my lawn in these little squares and everything's equal. Because again, as things change and the market moves and those companies get better, ideally, those percentages are going to fluctuate. So what's important is not necessarily being perfectly equal and manicured, but just putting enough initially and then letting it ride, letting it compound. And so if you're putting a good size in the beginning, then when that company does really, really well, you will get good results in your portfolio.

36:55When we look at Warren Buffett's best investments, we don't necessarily talk about the ones that went up the most in price. We talk about the ones that had the biggest impact to his portfolio, and he would put a quarter, 25 % of his portfolio in a single name. And so I aspire to be like that one day by just having really mastered the art or the skill of allocating a lot of the capital in a single name. Because again, it can be emotional and sometimes the stocks that are most emotionally riveting can also be those that trap you the most because you're getting caught up in and not being as rational as you should be.

37:48Right. I think that's a good example. You know, that makes me think of Zotus. You know, people that I've talked to like, oh, well, Zotus is down and continued to go down for a while now. And that's totally true. That is 100 percent true. But what I'm looking at is so Zotus is down because their patents ran out. And so now they have what are they called? Not aftermarket. It's not a car. Off brand. I don't remember the name. Generics. Thank you. They have generics. copying their patents now obviously that hits you hard and and the pharmacy you know you're selling a drug for a hundred dollars a pill now you get a generic for 20 like that's that's going to hit you hard um so uh what i'm trying to watch for is when their next patents are coming and they talk about it a lot on the earnings call and stuff things they're trying to do things they're trying to get patented and you know when and i'm not saying and i guess this kind of goes with trying to time it which is not it's not really what i'm trying to do it's just as i'm watching basically um you know zotus goes down a little bit more i buy a little bit more um and just waiting on them to get that next patent and if i can see it coming and just dump a bunch of shares into my portfolio great if not I think I have myself set up anyway pretty well for when their next patent comes which it'll come I'm very I believe it'll come and that will make me a very nice lucrative investment it'll be a very nice lucrative investment but I think that's the the biggest thing I learned from Buffett and just examining his letters and the way he taught or talked about what he did um is understanding the business its mechanics how it makes its money and then that is how you invest you're not solely investing on the name brand or the the moat or the the financial like you're you're investing also into how they're going to make their money in the long term.

40:14And I don't know if that makes sense. Maybe I'm not putting that as eloquently as I should, but ultimately like with Zotus, that's what I'm trying to do is just slowly load up on it so that when their next patent lands, I'm able to profit off. Yeah, no, that's cool. So what is, you think, the takeaway for investors who are struggling with sizing their portfolio? What kind of things can they think about? I would say first and foremost, if you're a day one brand new beginner and you have one or two companies, perfect. Like that is perfect. Just roll with it and let it build itself over time. don't be in a hurry um as andrew and i talked about like that is i think the biggest detriment to new investors is they try to hurry they feel like they have to hurry and you don't um history shows the stock market's going to be there tomorrow um so there's no rush just just take your time buy your companies that you believe in that you've done the research on to have a good valuation um you're buying at a good fair price and stick with them that's perfectly fine um if you maybe you're a little more seasoned and you hear me talking about you know i have 11 companies and i refuse to go past that um and you're looking at your portfolio and you've got 30 okay yeah if that's if that's what you are you're comfortable with and you're happy with and you can make a reasonable argument for having, who am I to tell you you're wrong?