Beginning Robinhood Investors: This Is How You Build a Market-Beating Portfolio

It wasn't a stretch to conclude that a pandemic would wreak havoc on daily life for many Americans. But how many people would have guessed that it would give birth to an entire new class of newbie investors?

With a little extra cash on hand (thanks, stimulus), a lot more free time (thanks, lockdowns), and a brand-new platform tailored to a younger-crowd (thanks, Robinhood), that's exactly what we got.

It hasn't all been smooth sailing. All too often, beginner investors -- many who have made a home on Robinhood's platform -- try to make a killing on a small handful of stocks. They pour their money into a couple names, hold them for days or weeks, and quickly sell.

I get it. It's exciting, gets your adrenaline pumping, and makes for an entertaining hobby. I wasn't that different when I started investing. Here's a link to my very first Motley Fool article years ago-- which saw me dumping huge sums into stocks like Rosetta Stone. Since then, the S&P 500 -- including dividends -- has increased 260%. Rosetta Stone? It's up just 30%.

And time alone hasn't rendered me immune to such mistakes. I lost large sums by placing big bets (over 5% of my portfolio) on stocks like GoPro and PagerDuty -- the latter occurring less than two years ago. The problem, I fell in love with the story behind the stocks and made a top-down decision to invest large sums. I didn't take into account the unknown unknowns -- all the ways my investment thesis could be wrong that I didn't even know about.

Making heavy bets on any stock simply isn't a good idea. Below, I'll show you how you really outperform the market -- for decades.

Image source: Getty Images.

But first, let me tell you a story about constructing a college campus that will shine a light on the importance of process.

When I was in college, there was nothing worse than going to the dining hall in winter. Our small school (Grinnell College in rural Iowa) had an enormous quad between my dorm room and the all-important buffet. The trek felt like choosing between two horrible options.

The problem: The paved path along the outskirts took about twice as long as cutting across the quad. When it was 10 below zero and the wind was howling off of the prairie, that sounded awful. But cutting across was equally daunting: A few feet of snow would inevitably end up in my boots. The paths my school originally paved appear organized, but aren't very functional.

Michigan State -- as well as a number of other schools -- realized the problem and created a solution. They simply looked at all of the "desired paths" people were taking -- those "shortcuts" that quickly wore down the grass around campus. And in those spots (when the environment allowed), they paved new "official" paths. It looks chaotic, but is very functional.

Think of the simplicity of the solution. Instead of a top-down approach that requires spending resources on solutions that may or may not work, it's a bottom-up approach that's all but guaranteed to work based on the wisdom of time and crowds. 

Highly concentrated portfolio? No problem...if this is true

There are strong correlations between this and how you construct your stock portfolio.

You might think that means I don't believe in running a concentrated portfolio. But you'd be 100% wrong. In fact, my top five holdings account for over 53% of my family's investments. That's enormously concentrated.

How can I justify that concentration while still espousing not making big bets?

In the end, I didn't make the big bets. The market created them. It might have been chaotic, but time and the wisdom of crowds dictated these become my largest holdings.

Here's what I mean. I've listed my five largest holdings below. In the first column, you see how much of my cost basis -- the amount of money originally invested -- was devoted to them. The second column tells you how much of the portfolio they account for now.

Data source: Author's records. Percent of holdings accurate as of Aug. 17, 2020.

About 20% of the money I've put in has grown to represent over 50% of what I have now. How did that happen? Time and the wisdom of crowds -- that's about it.

Take Shopify, for example. I invested a small sum in January 2017 and haven't sold a share since. The value of each share has gone from $45 to over $1,000. Much like those planners at Michigan State, I (eventually) learned to place smaller bets and let forces beyond my control dictate which would be the most important.

The hardest part isn't actually the discipline to keep the bets small -- it's not selling your winners. As my colleague Brian Feroldi likes to remind me: Water your flowers (winning stocks), not your weeds (losing stocks).

Yes, there comes a time when selling does make sense -- like when there are better places for your money or when one stock becomes too much of your holdings. But by and large, companies that have been performing well lately will continue to perform well into the future; their success often breeds bigger competitive advantages.

Therein lies the secret for beginning Robinhood investors looking to make a killing: Accept most of what you need to know you don't. Spread your bets evenly. Don't sell your winners.

Time and the markets will take care of the rest.