Reuters reported that Fitch downgraded Sony's (NYSE:SNE) debt to junk status. This is very interesting from the standpoint that any company, including Apple (NASDAQ:AAPL) (which we own for clients and the fund we sub-advise), can see its fortunes change such that they fail or become a small fraction of what they once were. In the 1980s and into the 1990s, Sony was a global powerhouse.
We've talked in this context about Kodak (EKDKQ.PK) but another one that still has a heartbeat is Xerox (NYSE:XRX). We could probably list a bunch of other truly and formerly iconic names that would make us say "oh yeah", but this is a common enough occurrence to better understand why position sizing is so important.
All too often, people get caught in positions that are too large at the wrong time. In the past when I've made similar comments, there were reader comments that disagree philosophically. This is of course ok, but what might not be ok is the confidence expressed about being able to see this sort turn coming in a company.
Of course there are people who can see the end (or serious negative changes) coming but that is not going to be the majority. Think about the parade of pundits who loved Apple at $700. I don't think the recent drop heralds the end by any means, but generically speaking, some 20% drops are serious and some are not. While it is quite clear to me that Apple is not in real trouble (I would not have bought after most of the recent decline from $700), I could be wrong; again the context here is more generic.
My approach is not let any single position be capable of causing a financial plan rewrite. How much is too much depends on the end user. If you owned ten stocks and you could not see a failure or near failure coming, would that type of hit be tolerable? Keep in mind that a failed company would be along the lines of permanently impaired capital, which is different than a portfolio of healthy companies that collectively go down 25% or 35% in a 30% bear market decline, only to then recover and go on to new highs. Kodak isn't going back to $90.
There is no single correct answer to the question above, only the answer right for you. Some past commenters have claimed to be comfortable with just five holdings, and chances are some of them actually are. There is no way that any sort of money manager investing other people's money could own just five stocks for too much litigation risk. I don't know about ten stocks, but since there are mutual funds with just 20 holdings, I imagine that number is ok for money managers investing on behalf of clients.
So if you really are a five stock person, then that is a potential advantage you have over a professional who might only want that number but can't. Well, a perceived advantage- until something blows up.