Number

You may ask: In that case, how many types of stocks should we hold for optimal, but not excessive, diversification?

I have no cut-and-dry answer.

When I first study how to pick stocks and build a portfolio, I was told that the ability of diversification (i.e. spreading the risk of a portfolio) reaches a peak when you hold 7 stocks. Any further increase in the number does not help to reduce the risk because it is likely that some of the stocks would have the risk overlap with each other. The statistical jargon is there is internal correlation.

(Unfortunately, I cannot find the reference or origin of this very number.)

How about me? At this moment, I owned 13 different stocks. In general, I try to keep it below 15 but at least 5. There was a brief moment during the financial tsunami that I hold only 3 stocks (Hong Kong China Gas, Link, and Yip’s Chemical). I don’t think this situation will ever happen again.

Diworsify

Frequent visitors of this site would have sensed my tinge of disagreement yesterday. Many of my friends would also point out immediately that I am all against (over) diversification.

My concern is simple: Although you may have an astronomical sum of money in your account (unfortunately, that doesn’t include me), your portfolio is always 100% in total. The more types of stock you hold, the less likely each one of them would make an impact on the overall performance. In fact, if you consider expanding your portfolio from 50 to 100 stocks, it is much more likely to hit some landmines in the second 50 than the first. In other words, the risk is not reduced by further diversification, but quite the opposite.

Alas, why don’t you put up more effort to choose the first 50, and, when you have extra money, put them back of these carefully chosen ones?

Or, let me put it like this:

The traditional teaching is: Don’t put all eggs in one basket.

My interpretation is: It doesn’t mean that you have to put each egg in a different basket.

By the way, the advise of Warren Buffett is: Put all your eggs in a few baskets – and watch them closely.

Limiting

Once you realize time is the limiting factor, it is tempting to jump to the conclusion that there are situations where prolific in good ideas and a wealth of excellent output could come together.

For example, in the case of investment.

The consideration is obvious: Although we all have only 24 hours a day and cannot work out as many good ideas as we could generate, you can certainly invest on as many stocks (or options, warrants, bonds, ELIs, and what not) as you like - provided that you have sufficient money.

In fact, this idea is well utilized by many mutual funds. For example, Peter Lynch is probably blessed by the muse of investment and could make use of almost aspect of ordinary  daily life – the Fidelity Fund under his management used to hold close to 1500 different stocks. (See One Up On Wall Street.)

They call it diversification.

Materialize

Yes, I mean what I say: Having many brilliant ideas does not coexist with carrying out a lot of work.

Important. I'm not saying having brilliant ideas does not always result in a lot of work. If I could play Aristotle for a moment, the two phrases are not subject (主詞) and predicate (謂詞), and the relation not a proposition (命題) (specifically, A or I type). What I mean is: The two conditions are mutually exclusive and could not happen together.

Why? It is because time is the limiting factor. For every good idea, you need fresh and blood to make it materialize. If one spend most of their time generating ideas, it is actually unlikely that he could have the time to work them out.

PS. When LS and I were giving a talk to the research students in Shanghai, we were asked how often do we generate useful research idea from reading journals. My reply was I would feel fortunate if I could have one good idea each year - after scanning through some 3000 research papers.

Execution

My primitive idea was simple. You've got to be smart to have good ideas, but it involves an entirely different aspect of capability to execute an idea - determination, planning, and endurance.

By the way, it is a common misconception that Emotional Intelligence means the ability to identify and control ones own emotion. In fact, the famous Stanford Marshmallow Experiment - the result of which correlates with the score of high school examination - tests whether a child accepts deferred gratification, not the ability of handling emotion as outlined in the models of Stanley Greenspan and Daniel Goleman.

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But, let's go one step forward. We should not always blame extraterrestrials (for example, administrators of research grants). As mentioned above, it is often the problem of ourselves rather than any extrinsic force. However, many a time it is a mathematical problem.

In fact, other than medical research, many things in our life could be taken as an example. The paradox is: having many brilliant ideas does not coexist with carrying out a lot of work.

Ideomotor

It is obvious that my friend VW was thinking about a different problem when he talked about people who keep having good ideas but none could be worked out.

The reason that he puts up was simple: They do not have the ability to complete a project.

My opinion is: this statement is a level one explanation of the problem. (For those who are not familiar with the five levels of understanding a problem, please refer to the black cylinder experiment - go read Practical Thinking of Edward de Bono.)

You may ask: Do I have some explanation of a higher level?

Unfortunately, no - although I am sure I have encountered more people with this very form of ideomotor dysfunction than our professor of hepatology.

My vague idea of analogy is: Having a good idea requires IQ, while working an idea out involves EQ.

Priority

In his recent blog entry, my friend VW outlined his plan of conducting a randomized control trial back in the days when he was a house officer. He went on and discussed why some people continue to have excellent research idea but they hardly bear any fruit. (See http://vwswong.blogspot.hk/2012/09/change.html)

Simple, eh?

No. It involves much deeper a water and actually several unrelated problems that may skip your eyes.

To begin with, an excellent research idea to one (especially when it is viewed with some hindsight) may not be at all interesting to the funding bodies - or, in the jargon of our friends outside the solar system, not having sufficiently high priority.

The sobering truth is, how our funding bodies rank research priority is no different from how the lay public choose which stock to buy: When everyone sees a great opportunity in a particular item, it usually means that  this item has already passed its prime time.