The often cited theory we referred to is that there is an optimum size for a share portfolio of around 15 or so stocks. The thinking goes that the additional diversification benefits gained from adding more are said to be minimal, and that as you buy more and more shares the likelihood of their performance being highly correlated with others in the same portfolio increases. That means you aren’t especially well protected from downside risk in the event of a wider market sell-off, will struggle to beat the index, and bear much higher costs than you would using a cheap tracker fund instead.
Mr Woodroffe disagrees: “If low cost trackers had been the rage in 2000, I might well be a lot poorer by now,” adding that had he followed suggested best practice and pared his portfolio down to a select few best ideas he may well have backed the wrong horses, too. “Some of my best investments have been ones which I was moderately enthusiastic about… 'best' ideas can turn out disappointing,” he says. His success, he adds, comes from disciplined stock selection – and focusing on large, dividend paying companies, leaving his small cap exposure to fund managers.
Being the editor of a magazine that encourages stock picking, I agree on many levels with his approach. Whilst not having a spectacular year, our own tips did beat the market in 2014 – and we picked a lot more than 80. And our experience also suggests that succesfully speculating on small caps is more difficult than many private investors would imagine - dull large cap and income tips proved the winners, as tips editor Algy Hall and I discuss in this week’s podcast.
I don’t want to write off tracker funds altogether, though, because they can provide a very solid, and cheap, foundation for a portfolio and wring out the proven benefits of asset allocation across geographies and asset classes. And while Mr Woodroffe is right to say that the performance would have been disappointing had he bought a tracker in 2000, it would have been much better had he bought in 2002. Timing and valuation still matter when buying whole markets – and we can use simple tools like PEG ratios to help in this regard. On that basis the S&P currently looks dear on a PEG of 1.7 and the FTSE 100 cheap on 0.7.
One final thought comes from Chris Dillow’s column this week, and that is that there are few black and white truths in investing - so what works for one person might not work for someone else. The important thing is to be like Mr Woodroffe and know what works for you.
