This One Really Was A Black Swan

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Includes: SCBFF
by: Roger Nusbaum

I think it was, anyway.

The black swan in question is the allegations about Standard Chartered (OTCPK:SCBFF) doing business with Iran and the trouble the bank could get into if true. The point of this article will not be to try to dissect the story, but rather explore the nature of getting blindsided by this sort of story that ends up taking a stock down a lot all at once.

Over the years I have been very specific about my belief in targeting individual stocks at 2%-3% of a portfolio in most instances. If Standard Chartered is accused of dealing with Iran and it is denying it, then there is a very good chance that this was not reasonably analyzable -- which is why I think this story counts as a black swan. Maybe this will be nothing and the stock will go back to where it was, in which case it will have been a black swan that just resulted in a bad week.

There are plenty of investors who prefer to have much larger allocations to their favorite stock picks, like 8%-10%. One observation I've made is that in a diversified portfolio of stocks there will be one that turns out to be the best performer over some random period of time, and one that will be the worst performer over the same random period of time. Layer on top of that that no one can be correct 100% of the time and you realize there is a good chance the worst performer will, in fact, go down. If you knew ahead of time that a stock would go down and be the worst performer, then you probably would not buy it.

If you can't know what the worst-performing stock will be, then how would know what the best-performing stock will be? If you use more than 10-15 individual stocks at a time in your portfolio mix, how often have you been surprised by what the top performer was for some period of time?

This is why I prefer 2%-3%. When a Standard Chartered-like event happens you won't get blown up, and when something does fantastically well, a 2%-3% starting point is large enough to be meaningful to the entire portfolio.

The other aspect to this type of story is the extent to which it is yet another anecdote that scares people away from individual stocks in favor of funds (obviously, if the stock fully recovers in a week it wouldn't scare too many people). The ETF landscape is continually evolving to offer new access, but there is still room for individual stocks to make for a more complete portfolio. ETFs could be the core with a few stocks to serve as the explorers, or a portfolio could consist of a diversified set of ETFs with a few individual stocks to add a higher dividend yield.

ETFs definitely can get a portfolio most of the way there, but individual stocks are still a crucial component (most of the time) too.