The Best Investment Can Be To Reinvest

Summary

Investing in a few carefully chosen companies and reinvesting in them over time can lead to significant returns, as opposed to excessive diversification which may dilute potential gains.

Abstract

The article suggests that a focused investment strategy, akin to honing a skill in a particular sport or instrument, can yield better returns than broad diversification. It emphasizes the importance of recognizing and capitalizing on a good investment by reinvesting in a company that continues to perform well. The concept of loss aversion is discussed, where investors are more likely to avoid risks when facing gains and take more risks when facing losses, which can lead to missed opportunities. The article argues for a balanced approach to diversification, advocating for a concentrated portfolio that one can manage effectively, as recommended by investment experts like Warren Buffett. The author posits that investing significantly in a few companies that one understands well and believes in can lead to better outcomes than spreading investments too thinly. The article concludes by citing William J. O’Neill, who advises aiming for a few substantial gains rather than numerous small profits.

Opinions

Investors should consider reinvesting in companies that consistently perform well, rather than solely focusing on initial investments.
Loss aversion can prevent investors from maximizing gains by discouraging additional investment as share prices rise.
A balanced approach to diversification is preferable; too much diversification can lead to investments that are too small to make a significant impact or too difficult to manage effectively.
It is more advantageous to have a concentrated portfolio of stocks that one can thoroughly understand and monitor.
Investors should trust their judgment when they find a "wonderful company" at a fair price and continue to buy shares over time.
Regretting not diversifying less, in hindsight, is counterproductive and leads to bias.
The ultimate goal of investing should be to achieve significant returns from a few key investments, rather than settling for many small gains.

The Best Investment Can Be To Reinvest

From a young age, we learn to try out different things or sports to discover what we are good at. If we stumble on something we like and we are good at; we are more likely to keep playing soccer or the piano. We also tend to avoid the activities we didn’t like or didn’t excel in during our experiment journey.

When you invest, it is possible to find a wonderful company with a fair share price through research. However, most investors are likely to invest once in such a company and hold their shares for the long-term. We are less likely to have the following mindset; when something is good, you can use some more of it. However, making this part of your investment strategy can benefit you.

Loss-aversion holds you back Daniel Kahneman and Amos Tversky conducted research on loss aversion and risk-taking. Their studies revealed that in a hypothetical situation losing 100 dollars has a more negative effect on you than gaining 100 dollars. This is called loss aversion which is beneficial most times because you will remember a negative event more vividly which often leads to being more careful next time. You could wonder how this may affect my investments. Below, I give you an example.

After you have conducted your research, you bought shares of a company for a fair price. The company’s revenue keeps growing, is recognized by the market, and therefore their share price rises. Until now, you have a wonderful return of investment and believe in the company’s growth. You intend to hold your investments, but you are less likely to buy more shares of the company because the share price is going up. If you buy more shares, your cost per share increases and a part of your (virtual) gains decreases. Research proves we are more likely to be risk averse when dealing with gains and risk-seeking when experiencing losses. Below there is an example.

When you have the choice between a probability of 50% to win 200 dollars or the certainty of 100 dollars most individuals will choose the latter. However, when it becomes a decision between a chance of 50% to lose 200 dollars or losing 100 dollars, the former is often preferred.

Finding the balance of diversification When I started to invest, I was often thinking about the importance of diversification. To not put all your eggs in one basket because otherwise you aren’t protecting yourself from risk. This could sound familiar to you. However, you don’t want to be too diversified because it’s difficult to do your homework on a dozen companies. You could ask yourself the following; Do you have the time to keep on top of several companies in your portfolio? Most of us don’t and therefore investment experts recommend having a concentrated portfolio of a few stocks you can track. Warren Buffett recommends investing within your competence because you are more likely to have the required knowledge about your investments.

I believe the following; if you know what you own and are able to sit out the storm which happens from time to time, it’s better to invest a significant amount in a few stocks. The reason is that you otherwise spread your investment too thin. You are likely to invest too little in companies you truly believe in and too much in companies you believe less in. Would you spread your favorite spread too thin on your bread? Or would you stop eating your favorite spread because the price goes up? I know the answer to that. Therefore, buying the investments you believe in over time could benefit you more than preferring to invest in a dozen stocks because of the sake of diversification.

Regretting that your return of investment could have been greater if you diversified less is not the purpose of investing and only leads to hindsight bias. On the other hand, investors who diversify are also less likely to lose a lot of money with one of their investments. However, they aren’t protected from a general pullback in the market and can lose a lot of money with multiple investments because it’s difficult to keep up to date. Trusting your gut when you see a wonderful company at a fair price and keep buying their shares over time could be your best investment. William J. O’Neill said the following in his book How To Make Money In Stock;

The winning investor’s objective should be to have one or two big winners rather than dozens of very small profits

Thank you for reading and I wish you a nice day