Position/Portfolio Weight & Diversification Discussion - I've had a number of off-thread chats with individuals, both electronically and physically. There are many, many ways to construct your portfolios for maximum returns AND maximum physical and psychological comfort, which is just as important. Just like a home, you want to own your stocks, you don't want your stocks to own you.
Your diversification for each set of accounts is very important. If it's out of balance, so to will be your results, financially and psychologically. Now, I'd be remiss if I didn't admit that an out of balance weighting can also then provide significant alpha (outperformance) as well. The key to this is understanding when you are overweighting and when you are gambling, and to the degree its done.
I'm not one who subscribes to making sure ALL of my portfolios are balanced unto themselves across taxable and non-taxable accounts. I have three separate weightings:
1. Taxable
2. Regular IRA
3. Roth IRA
My taxable account is weighted as best I can to ensure safety, fundamental valuation and especially income. My regular IRA is weighted more toward growth priority and secondarily income, but with more emphasis on effective weighting to ensure no single position is too out of balance. If you noted that I stated this is for my "regular IRA" and not my taxable account, I'll speak to this shortly.
My Roth IRA is a smaller account and is my high beta (risk) capital gains sandbox and has weightings I wouldn't suggest for anyone I speak to or work with. In short, high growth, high risk, and a pure focus on capital appreciation.
Looping back to talk about my taxable accounts, these portfolios are made up a three sets of accounts. One for current year cash need, one for a 5-6 year fixed income ladder (no equities) and one for everything left over, primarily not needed for at least 7 years. The cash and fixed income ladder is simply to maximize yield and income via non-equity vehicles: Money market, Bonds and CDs. As one year rolls off and is moved to my current year cash needs, usually on 1/1 of each new year, a sum of money waterfalls from 7+ into the non-equity fixed income account to make up for the moved cash. In this way I always have at least 5-6 years of very safe cash available to take the reliance off the stock market should we hit a rough patch. I can simply ride it out.
An interesting thing happened on the way to early retirement. To some degree, I mismanaged my taxable accounts and allowed some positions (AAPL, MSFT, GOOGL) to get too overweight over the decades to the point where I am now limited in what I can do to right-size them due to capital gains and income impact. Capital gains are one thing but raising income also impacts other early retirement factors such as health care subsidies (if any), capital gains tax brackets, and income tax brackets. I have a plan to scale out of these positions while balancing the tax impact but it will take time.
So, let's talk about proper weighting and diversification that most should be using to ensure they have proper risk/opportunity alignment for all around balance and safety. Each individual will have their own tolerances and adherence to these tolerances and constructs is very important. Designing a good weight/diversification mix will usher in years of good growth and opportunity as you transition through different life phases including retirement or early retirement.
Mine is as follows:
"Best Idea" Positions 4%-6%+: I'll only have one or two of these at a time because they can be overweight, especially if they are performing well. The greater the % over 5%, the greater the chance the position will be trimmed based on company performance into market performance.
Core Holdings 1% - 4%: These are positions that represent the core of my portfolio, companies I evaluate and expect to hold for an extended period of time. My level of trust and performance for these positions dictates whether it will be closer to 1% or 4%. It's not uncommon for a stock with exceedingly good performance to rise close to, or beyond, 4%. When that occurs, trimming the position often occurs and it's how I keep greed in check and ensure the positions remain balanced within my portfolio.
Building/New Positions <1%: These are positions that I'm scaling into with the potential that they become a core holding. If you've followed me for any length of time, you know I profess establishing full positions over time in 3-5 separate trades unless it is a day/position trade. Breaking up your purchases 3-5 trades helps smooth your cost of entry and keeps some dry powder available in case a market/stock event presents weakness.
Speculation Position <1%: Speculative positions are just that. They are my sandbox trades and usually represent companies with a lot of risk but a lot of upside. I limit the number of these in my portfolio to reduce overall risk. I don't like having more than 2-3 longer term speculation positions. As such, they won't be weighted heavily overall.
Position Trades <1%: Very similar to speculation positions, these positions are less than 1% and I rarely have more that 2-3 of them in play at any one time. Current recent names that are on this list are CLF, SOUN and TNA. These positions could be one day holds or a couple months. Because the positions are kept small, time frame isn't an issue. I'm simply looking for 10%+ of move and I'm not married to the stock. Short term call positions can also fall into this category. For example, my recent entry into NVDA 12/24 $105 Calls. Purely a short term position trade on what I believe is an market based opportunity.
When breaking this all down in my primary portfolio that makes up a majority of the moves you see on this thread, the number of each type of category will look something like the following:
Best Idea Positions (2)
Core Positions (25)
Building Positions (5)
Speculative Positions (2)
Position Trades (2)
Obviously, these positions are rising and falling as new opportunities present themselves, I elevate a position, trim a position or retrench based on what the markets are doing.
What is Trimming and why do we do it?
I've actually had a couple of questions about trimming and have seen questions about it on stock boards as to how to do it or even "why" to do it.
Let me start by saying trimming a stock is one of the most difficult things to do for me, especially if it is a well-performing position.
In short, we "trim" positions to keep them well balanced and properly weighted within our portfolios, it's as simple as that. We may trim because the story has changed on an issue, performance has degraded or, as is usually the case with me, the stock has become overweight due to upside performance. In every situation, it's a "difficult but necessary" tactic.
Keeping greed in check is one of those strategies that will help protect your account from unforeseen risk or periods of market volatility. When stocks materially rise, so do the opportunities for material decline. As stocks rise above a level of fundamental valuation, they become more susceptible to revaluation events. Market fear, economic performance, financial performance or even unrelated events can cause markets to unwind and this will usually impact inflated or overvalued stocks to the greatest % degree. It may not matter how trendy, growth oriented or well-performing a stock is or has been recently, valuation events can cause revaluation events. This is why we trim.
It's a necessary tactic and what helps me to make the move each time is remembering that I can always repurchased those shares in the future if I want them back.
I'm not going into the specifics of my recent trimmings but will simply list some of my best performing stocks that I've trimmed recently based on performance. Some of these I've added back to already. You can take a look at each of them to see how they have performed since being trimmed. Here are the issues and the price at which I trimmed:
NVDA @ $129, $134, $131 and $128
CRWD @ $364, $295 and $253
JPM @ $203.24
C @ $63.78
DLR @ $159.02
K @ $75.06
DKNG @ $32.70
ABBV @ $188.71
MMM @ $126.15
WYNN @ $76.55
BAC @ $38.37 and $42.18
PANW @ $322.66
DE @ $400.85
GOOGL @ $171.02
As you can see, most of these were sold at much higher prices and it was difficult every time. Some (WYNN, DKNG) were sold based on lack of performance. It is difficult because of how well the stocks were doing but, if you cross reference sold price and current price, you can easily see why/how trimming can work and why it's so important.
And now I have the opportunity to add some of these names back at a lesser cost.
Hope that helps articulate how I use weighting to construct my portfolios and how/why trimming can and should be used to keep greed in check and safeguard your money.
J |
