Building a successful investment portfolio isn’t just about identifying top performing stocks or following market trends. It’s about designing a coherent strategy that balances growth with protection. A strategy that provides guidance in both, periods of expansion and recession. At FinanceGarrison, we believe this balance begins with the principles of Portfolio Theory, shaped by real-world constraints and a deep understanding of investor psychology. This guide provides practical strategies based on what has proven effective for us in the markets.
Each section of this guide includes a Garrison Insight—a practical takeaway based on real-world experience. These insights highlight the strategiesand habits that have worked for us in the markets. They’re not theory or fluff, but actionable advice drawn from actual trading decisions and portfolio management.
Diversification
Diversification is often misunderstood. It’s not about simply holding a large number of stocks. It’s about strategically selecting assets that don’t move in perfect sync. This is, not just investing in a large range of companies but investing in companies that trade in different geographical markets and from different sectors.
According to Modern Portfolio Theory (MPT), diversification allows investors to optimize their portfolio’s risk-return trade-off. When you hold assets that are not perfectly correlated, the overall volatility of the portfolio decreases, even if some individual investments are risky. For this reason, checking for correlation between stocks is a good idea before making any investment decision.
Garrison Insight
We advocate for owning between 10 and 20 companies. Here’s why this range works best:
- Fewer than 10 stocks: Your portfolio becomes vulnerable to individual company performance. A single earnings miss or scandal could significantly impact your overall returns. Even if your valuation of a company is accurate, holding only a few stocks can test your patience, especially if results take time to materialize. This impatience often leads investors to abandon good positions too early. While fixed trading commissions can discourage building a broader portfolio, it’s worth exploring lower-cost options like ETFs, which allow for greater diversification without excessive fees.
- More than 20 stocks: At this point, the marginal benefit of additional diversification begins to disappear. You may end up replicating an index without realizing it, diluting your ability to beat the market. For retail investors, it’s realistically difficult to track and manage more than 20 individual companies in detail. If you consider yourself risk-averse, this level of oversight may feel overwhelming. In that case, individual stocks might not be the most suitable option.
Risk Aversion
The concept of risk aversion helps explain why investors often make suboptimal decisions, like selling during downturns or holding too much cash. This tendency is backed by behavioral economics and was explored in depth by psychologists Daniel Kahneman and Amos Tversky in their seminal paper, “Prospect Theory: An Analysis of Decision under Risk” (1979).
“For most people, the pain of losing is psychologically about twice as powerful as the pleasure of gaining.”
— Kahneman & Tversky
Their research introduced the concept of loss aversion, showing that people would rather avoid losses than chase equivalent gains even when the math says otherwise. Below there is a graph that depicts this phenomenon. For gains and losses of the same amount, losses are perceived as more significant and have a stronger negative impact on a person’s overall utility than an equivalent gain would have a positive one.
Much of the common risk aversion toward smaller investments can be traced to two well-known behavioral biases. The first is loss aversion, where people tend to fear losses more than they value equivalent gains. The second is narrow framing, where individuals consider risks as if there’s only a single possible outcome—similar to flipping a coin once—rather than seeing them as part of a broader range of outcomes, like flipping 50 coins. These two biases together help explain the unique set of preferences described in prospect theory, developed by Daniel Kahneman and Amos Tversky, which was a key factor in Kahneman receiving the Nobel Prize in Economics
Garrison Insight
One of the most practical ways to overcome risk aversion and decision paralysis during uncertain times is to put a predefined strategy in place before negative events occur. When markets turn volatile or an investment begins to lose value, it becomes extremely difficult to think clearly. Emotional biases, especially loss aversion, often cause investors to freeze, avoid action, or hold onto failing assets in the hope of recovery. For example, setting rules such as selling a stock if it reaches a certain thresehold (say a support) allows decisions to be executed objectively.
Another powerful tool to prevent inertia is the use of time-bound investment instruments like options. These instruments expire at a set date, forcing investors to make a decision by a deadline. This structure limits the temptation to hold underperforming investments indefinitely, hoping for a turnaround.
A common behavioral bias among investors is the tendency to sell winning investments too quickly and hold onto losing ones for too long. When a stock begins to rise, investors like us tend to sell to early fearing gains might disappear. On the other hand, when a stock drops, investors often hesitate to sell, hoping it will recover and justify the original decision. This “sell winners, hold losers” mentality is driven by the discomfort of regret and the illusion of control. Unfortunately, it often leads to poor long-term outcomes, and this is why a predefined strategy plays a key role in any investment approach.
Sector Allocation and Geographical Market
Sector allocation is vital to managing risk. Relying too heavily on one industry, like tech or energy, can lead to sharp losses if that sector underperforms. By diversifying across sectors such as healthcare, consumer goods, and financials you smooth out performance across different market cycles and reduce volatility in your portfolio.
Geographic diversification works the same way. Investing across multiple regions like the U.S, Europe, Asia, and emerging markets helps protect your portfolio from country-specific risks and allows you to benefit from growth in different parts of the world. Together, sector and geographic balance support a more stable, long-term investment strategy
Products like the MSCI World highlight the importance of both sector and geographic diversification. The MSCI World includes a broad range of companies across multiple industries and more than 20 developed countries, making it a well-balanced representation of the global equity market. By spreading exposure across different sectors and regions, it helps reduce the impact of localized downturns or industry-specific shocks.
