Should you stop picking stocks?

Have you felt good about making a great stock pick or about booking profits on a position that has done well? But have you stepped back to think about the impact of your latest stock pick on your overall portfolio? In the process of picking stocks that look attractive by themselves, you may have built a monster of a portfolio - a risky and undiversified investment that in aggregate, is doing less well than you think. Does your overall portfolio matter? Yes, because in reality, what you earn is your overall portfolio return. The portfolio approach to equities is a unique approach to equity investment - one that fund managers and individuals can use to generate superior portfolio returns in a safe, sustainable and systematic way. Portfolio investing is unconventional and out of the box, and often goes against popular investment principles. Here are five telling examples:

Diversification is not for dummies

Stock picking focuses on holding large positions in a few key stocks, and criticizes diversification for spreading your bets too thin. A portfolio approach will build a systematically diversified portfolio - one that will outperform the market in small amounts that become significant over time. It is also a natural form of risk management - by holding smaller positions across a larger number of stocks, you will minimize the losses your portfolio incurs when a stock tanks on fraud, so-called operator manipulation, or poor performance.  How can you diversify your portfolio? It goes beyond holding a large number of stocks. Are the stocks you are holding all concentrated in one sector, particularly flavour of the season ones like infrastructure? You may be in for a rude shock if there is an unexpected regulatory change.  Do many of the stocks you own belong to one promoter group, e.g. Anil Dhirubhai Ambani Group? A promoter specific court case may have an unexpected impact on your investments.

Booking profits may be a bad idea

Stock picking wisdom tells you to "book profits" on stocks which you have made money on.  While selling based on when you have bought may seem sensible, you may sell winning stocks too soon and that is why momentum, as an investment strategy, makes money. In reality, you should sell a stock when it is no longer attractive to hold - and a stock's inherent value has nothing to do with the price an individual investor bought it at. A portfolio approach will only sell a stock when it no longer looks attractive in the portfolio, regardless of what its purchase price was. Investors also book profits to "raise cash", but very often end up re-investing that cash into the same portfolio.  But if you buy Reliance at 1500, sell it at 2000, and re-invest it again at 2500, you have really gained very little - except a long bill for brokerage, STT, and capital gains tax. In a portfolio approach, if you want to truly raise cash, you will proportionately withdraw out of your portfolio.

Stop losses may be a losing strategy

Investors and managers will often put a stop loss on individual stocks in the portfolio - a value of the stock at which they will sell out of the stock. It may be based on what they bought the stock at or at a key technical level. A stop loss, however, is an arbitrary measure that has little to do with the inherent value of a stock, and may lead you to selling a fundamentally good stock unintentionally. Focusing on stock level stop losses also distracts from the bigger picture - the performance of your overall portfolio. A portfolio approach looks at your overall portfolio performance - what you actually have gained or lost - and implements drawdown control on your portfolio. As your entire portfolio loses money, it systematically and quantitatively moves your equity holdings to cash in order to protect your portfolio. As the market and your portfolio come back, it starts increasing the allocation to equities.