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47 - Forced Diversification and Illiquid Stocks

The DIY Investing Podcast: Value Investing | Fundamental Analysis | Mental Models | Business Management

Release Date: 10/20/2019

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Mental Models discussed in this podcast:

  • Liquidity
  • Diversification

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Show Outline: Forced Diversification and Illiquid Stocks

The full show notes for this episode are available at https://www.diyinvesting.org/Episode47

Illiquid Stocks

  • Offer the chance for higher returns with lower risk
  • Less competition from professional investors

Forced Diversification

  • Can be caused by either:
    • Insufficient stock liquidity
    • Insufficient Conviction in High-Quality Ideas
  • Don't dilute your returns with low-quality ideas held in too large of a position size
  • My goal: Hold 5 stocks at 20% each. 
    • Currently, I am unable to achieve this goal because I do not have five ideas that are good enough to be worthy of a 20% position. 

Summary

Illiquid stocks offer substantial opportunity, but can also lead to an inability to purchase as many shares as you would like. This situation, along with a lack of good ideas, can lead you to rationally diversifying your portfolio more than intended. Cash has a high opportunity cost, so it is okay to build small positions in companies that are still high quality, but may not currently trade at wonderful prices. 

However, stick to your strategy and don't build full positions in companies if they do not meet both your quality and price standards.