The Mixed Nuts Approach to Building a Portfolio

Oct 25, 2006 by Adam C. Powell, Ph.D.

When you buy a can of mixed nuts, it is often useful to look at the contents label before making a purchase. Some really bored people decided to empirically determine the percentage of a can of Planter’s Mixed Nuts that was peanuts. The can said “less than 50% peanuts,” so the experimenters decided to determine whether this was true. In order to do this, they first counted how many nuts there were of each variety. Using this approach, they determined that 253 of the 371 nuts (67%) were peanuts. However, this finding was flawed, as they forgot to adjust for the relative weights of the nuts. After doing so, they realized that the 167g of peanuts in the container only accounted for 51.1% of the mass of the nuts.

What does this have to do with investing? Well, the lesson is in the importance of weighting. Stock prices are irrelevant when determining the initial composition of your portfolio. When deciding how much to invest in XYZ, you should not care if there are 1 million shares trading at $10/share, or if there are 2 million shares trading at $5/share. As an investor, your goal is to get a percentage gain. So, when you initially construct your portfolio, you should think of the overall “stock mass” that each investment contributes. How many shares (or nuts) of any individual stock you own is not a number worthy of much consideration. What you should do instead is to first figure out your desired percentage mix of stocks (i.e. I want a portfolio that is 50% invested in peanuts), and then buy enough shares to meet that goal. If you want to have your portfolio be 10% shares of XYZ, then you should simply take the amount of money you want to invest in XYZ, and divide it by the share price of XYZ. That way, you are thinking like Planter’s, considering the mass contribution of each type of nut, and not merely the overall number of nuts of each type.