My move away from traditional stock picking process

I cannot exactly remember what was the thing that made me so much interested in the Investment management business. If my memory serves me right, I think it was a documentary of Warren Buffet that I saw about 9 years ago. It was really something special, a true eye-opener for me, at least at that time. From there onwards, I got introduced to the world of value investing and along with that many such notable value investors like Charlie Munger, Joel Greenblatt, Monish Phabrai, Guy Spier just to name a few. I read everything I could find for free on the internet. After that, I went for books thinking that this is the secret to success. And, by success here I mean to make big money. As time went on, I began to dig deeper into the world of investments and different investment and trading strategies. At this point, I had pretty much a thorough understanding of how do value investing works. 

After a while, I started to realize many things that I felt pretty uncomfortable about. The whole idea of investments started to seem like a big game of information asymmetry. I will give you an example. Suppose an individual investor has a couple of thousand dollars to invest which he had saved from his monthly salary. Let's also imagine that the person believes in value investing and thinks that this particular strategy suits him the best. That's great. Essentially, what value investing preaches is to buy an asset at a price that is significantly lower than its intrinsic value. The mantra is that price is what you pay and value is what you get. Up to this point, I fully agree, and makes total sense to me. Now, again going back to our individual investor, let's say he finds a good bargain. The company's balance sheet looks great, cash flow positive, management seems to know what they are doing but for some reason, the market is not liking the stock. 

What value investing says or rather what value investors do is that they start to buy the shares of the company and take a massive position in it. If you look at any well-known value investor's portfolio, you will find on average only a handful of securities. It depends on the fund size that the manager has but what I am trying to say is that the positions are fairly concentrated. This is one of the common characteristics of a value investor. Now, this is where I start to have a problem. This problem might be stemming from the fact that I am doing my Masters in Finance right now and the literature of modern portfolio theory is very fresh in my head. Nevertheless, to have a diversified portfolio totally make sense. Why in the world you wanna take a position that is so concentrated that the risk-reward ratio is just not worth it. 

Almost all the time, people like to give the example of Warren Buffett as a role model for pursuing value investing. However, I believe that people most often than not forget to realize the fact that having a USD 150 to 200 billion in cash and having a small saving spared from their annual salary is totally different things. Whenever Buffett is buying shares of companies, he spends a billion dollars at a time. That is massive. And with the reputation he has, he easily gets to sit on the board. Even though we all know that he does not like to interfere with management's decisions and operations, he has significant power in what happens in the long run of a company. Now, take an example of an average individual investor. It is a completely different story. Not only the person has to be right with regards to her fundamental company analysis, but also with market timing, macroeconomic analysis, her own liquidity needs, etc. We haven't even gone into the psychology and behavioral aspects of the game until now. That is another massive field in which investors have to be cautious.

Hence, I think individual investors like you and me are much better buying a broad-based index ETF than holding some big position of our portfolio in a couple of stocks. I think at this point, everybody is quite aware of the fact that equity mutual funds are not worth it. They have been underperforming the markets for the last 30 years and on top of that charging significantly more in fees. Not surprisingly, the investors are moving to Exchange Traded Fund (ETF). Now, that does not mean that you don't have to dour research. Things like expense ratio (less is better), AUM (more is better), Dividend policy ( distributing vs accumulating), fund domicile, etc. are the basic information that every ETF investor should know. 

Now, I will tell you when I think buying individual stocks would be a good idea. So, if you are researching a certain company and find it very attractive relative to its current valuation. It would be a good idea to take a huge bet on it if and only if you can buy so big of a position that it allows you to sit on the board of the company. Now, you can look at the company from a totally different lens. You shall now have the latest information about the company's plan and projects. You can actively participate in it. You shall have your say in the decisions proposed by the management. I am cool with this approach. 

So, on an ending note, what I want to say is that don't try to copy these big-time investors. It just doesn't work like that. You have to find your own way and figure out what makes you feel comfortable in your own investment journey. But, whatever you do, do not forget that the only free lunch available in finance is "diversification". DIVERSIFY, DIVERSIFY, DIVERSIFY...!