As I get back into the flow of investing -- after a bit of an investing hiatus during most of my college years -- I find myself returning to questions that many new investors tend to ask. It is fair to say that I am still in the process of determining the best strategy for my own portfolio.
I am still young enough where I can "experiment" with different strategies without losing sleep at night. For instance, I think the Pencils IRA Project will be a fun project to run for at least a year (maybe more depending on community interest and how the portfolio is performing), and then track over the next 5-10 years and beyond. I think identifying businesses with dynamic management, strong company cultures, and innovative product lines could be a sound market-beating strategy for the long haul. Time will tell based on how well this particular project does over the next several years.
Most importantly, for me, is that the Pencils IRA Project gives me the opportunity to write my analyses and reasoning and track them over time. This is something that every investor should do -- regardless of their individual strategy -- in order to allow meaningful reflection and learning as we invest.
Focusing on long-term potential of businesses has also helped me tune out short-term market noise. I remind myself that I am not investing in a business based on speculation from me (or others, for that matter) of where the stock will be in three months. I happened to start investing in 2005 and 2006, essentially the peak of the bull market before the market began to fade and the economy eventually entered the Great Recession. I got discouraged with my portfolio's performance atprecisely the time I should have been buying -- this is not a mistake I plan on repeating.
My timing of entering the market may be similar this time around (you've been warned). I don't know where the market is going the next several months... nobody does. Looking back on the first investments I made nearly nine years ago, however, I see that the greatest investments in my portfolio stemmed from businesses with innovative product lines guided by dedicated and visionary leadership who had a focus on long-term performance: Chipotle, Netflix, Monster Energy, etc. This is why I am placing such an emphasis on these traits as I begin to get back into my investing flow. I truly want to focus on businesses that can flourish over the next ten years and beyond. It is critical to find leadership dedicated to (and capable of) sustaining long-term growth for all stakeholders.
With all this said, below is an article I wrote expanding on some of these thoughts with regard to allocating funds within a portfolio and building a strong portfolio for long-term success. I hope these thoughts are helpful to some!
Building a Portfolio for Long-Term Success: http://www.fool.com/investing/general/2014/04/09/building-a-...
New investors often ask the question, "How much money should I allocate to each investment I make?"
This is a great question! And the honest, realistic, and Foolish answer? It depends on the investor.
Mold your strategy around you
In a working adult's IRA, the dollar amount allotted to each investment will likely be considerably higher than what I can allocate to investments in my individual portfolio as a student in college.
Even so, the meager $80 I invested in Netflix (NFLX) in 2006 is worth well over $1,000 today. Netflix ballooned from 5 million subscribers in 2006 to more than 44 million subscribers in 2013 and counting, expanding sales at an average rate of 23.5% annually between 2006 and 2013.
Netflix shareholders have benefited greatly from the visionary leadership of co-founder and CEO Reed Hastings, who from the very beginning recognized the need for Netflix to adapt to new mediums.
In his 2005 letter to shareholders, Hastings wrote, "The winners in downloading will be the companies that provide the best content and the best consumer experience, and that's what we do best." Less than a decade later, not only is Netflix an undisputed leader in streaming movies and TV programs, but the company is also producing its own original content. What a difference visionary leadership, an innovative product, and 10 years can make.
As you search for your own multibagger investments, keep in mind these (paraphrased) words of popular Motley Fool member Tom Engle (TMF1000): "If a company is the next big thing, a little position is all I need. If it isn't the next big thing, a little position is all a want."
Peter Lynch, investor extraordinaire and former manager of Fidelity's Magellan Fund, puts it this way: "All you need for a lifetime of successful investing is a few big winners, and the pluses from those will overwhelm the minuses from the stocks that don't work out."
In other words, individual investors don't have to bet big and commit all of their investing money to one or two investments. Building a diversified portfolio of quality businesses with great long-term prospects is the best way to achieve market-beating results over the long haul.
With this in mind, it is helpful to focus on percentage allocation, rather than the dollar amount invested in each stock. A rule of thumb used by some investors is to invest enough funds in each position so that commissions make up no more than 2% of your total investment. In other words: If your brokerage charges you $7 to buy shares of a stock, the minimum amount you would want to invest with each trade would be $350 (of which 2% is $7). This helps ensure that commissions do not eat up a significant portion of your investing dollars.
Opportunities with diversification
When a stock jumps in the short term, it can be easy to convince ourselves that we should have purchased more shares of that stock. But would you have felt comfortable holding a larger position if the stock had dropped 20%? Consider this when determining how much you want to invest in any given business.
We should be confident in all of our investments, but the benefit of diversification is that we can begin to look past the short-term volatility that will inevitably come about when investing in individual stocks. So consider expanding your portfolio beyond just a handful of stocks. We want to invest enough so that we benefit if a business succeeds over the long haul, but we also don't want to invest so much in one position that we hyper-analyze every little market movement and panic if the stock doesn't perform as anticipated.
Some investors opt to "buy in thirds," easing into individual stocks by purchasing their total position in increments of one-third over time. A potential downside to this strategy is the fact that the long-term trend for the market is to go up, in which case delaying investments into thirds over time can sometimes be counterproductive (or less rewarding than opening a full position from the get-go). On the other hand, going all-in with a full position right away can be difficult to stomach if the market or the individual stock should take a turn for the worse.
Foolish bottom line
It is important to manage your portfolio in such a way that leads you to focus more on the underlying businesses behind your stocks -- and the long-term prospects of those businesses -- rather than getting caught up in short-term market movements. Allocate your money in such a way that maximizes your confidence and comfort levels and minimizes uneasiness with your investments, allowing you to keep the bigger picture in mind. Volatility is all but guaranteed with individual stocks, but focusing on the business behind each stock can help investors avoid emotionally driven decisions based on short-term price swings.
The Pencils IRA Project -- a personal real-money portfolio -- is my attempt to build a portfolio of quality businesses with significant potential to generate market-beating results over the long term. The dollar amounts allocated to the individual positions in this Roth IRA portfolio are nothing huge, but the portfolio will prove to be lucrative over the long haul if only a few of the holdings prove to be big winners. With investing, starting small is better than not starting at all.
Thanks for reading!
David K [more]