Both new and experienced investors face a dizzying array of investment choices. Starting with broad asset classes, narrowing down to specific industries, and then selecting specific securities results in limitless combinations that stretch the abilities of computing power. Such confusion often leads to paralysis.
Some investors prefer focusing on the small details to generate ideas; others rely upon big ideas. While both approaches have merits and can lead to excellent results, the five main benefits of using big ideas are:
- Simplicity – This is the main benefit of relying on big ideas. Investors can examine the markets from a macro perspective and decide which ideas to follow. The research approach is clear and time is spent on actionable items.
- Risk Management – Studies show that investors must hold thirty different assets to achieve optimal diversification. For some, the time required to amass such a portfolio is too great. Instead, focus on the ideas you strongly support and use them to offset risks between asset classes.
- Efficiency – Time is spent studying the economy and markets instead of individual stocks and bonds. This allows you to spend less time looking at computer models and to manage investments effectively without them dominating your life.
- Global Themes – All of Wall Street is obsessed with second derivative movements. Instead of predicting how the economy will perform, investors watch for market reaction to the economy. Big ideas cut through this clutter by driving straight to how we expect asset prices to behave over long cycles and taking the proper position.
- Conviction – Academics define risk as the volatility of returns. At first glance this may seem odd, but investors know how true the statement is. One of the hardest things to do is take a position, have the market move against you, and maintain your convictions. If your investments are scattered across many different securities, it might be difficult to maintain the conviction that your thesis is correct. Focus on a few areas you strongly believe in and the likelihood that you can stick to your initial game plan increases.
In volatile markets, placing trades in which you strongly believe allows you to build a framework of positions that can be maintained through difficult periods. Investors focusing on the few big ideas in which they most firmly believe increase the reliability of this framework.
Sean Hannon, CFA, CFP is a professional fund manager.
Other recent posts by Sean:
- Understanding the Modern Portfolio Theory (MPT)
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- 5 Assumptions of Macro Investing
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View all Posts by Sean Hannon.