From Cabot Wealth Advisory free e-newsletter
Nearly every week we have a conversation with a subscriber who wants us to look at his stock investment portfolio and tell him what we think. We happily oblige, but are then bombarded by a list of the 25 or 30 stocks he owns!
Many of these stocks might look good, but our response is always the same—we tell the subscriber that he owns too many stocks.
Both professional and novice investors fall into this portfolio management trap. They forget that the objective is to make money, not to own every good-looking stock in the market. Historically, most successful growth stock investors have concentrated their investment portfolios in a few great stocks, and ridden those winners to big profits. That doesn't mean you should put all your eggs in one basket. Our advice is that, when fully invested, you should own no fewer than five stocks, but put an upper limit at 12 or 15 stocks. There are three main benefits of good portfolio management.
First, you can keep up with all your stocks, and track what's happening at the companies. We do this full-time, more than 40 hours per week, but even we have trouble keeping track of two or three dozen stocks. So how's an individual going to do so?
Second, you'll get more bang for your buck. Really, it's simple math. If you own 25 stocks, each stock is about 4% of your portfolio. So if one of those stocks rises 50%, your overall portfolio rises just 2% (4% X 50% = 2%). And that's before taxes, which can bite off one-third or more of your profit. Ask yourself, how often do you find a stock that rises 50% or more in just a few months? In our experience, we pick just a handful of such stocks each year. So we want to make the most out of them! (If you own just eight stocks, and one of your stocks rises 50%, your overall portfolio is up more than 6%, a solid figure.)
Now, you may object that, "if my stock falls 50% it will do much more damage to a concentrated stock portfolio!" But if you always cut your losses short, you don't have to worry about this scenario. Thus, even in a concentrated portfolio, you can keep your risk at a tolerable level by cutting losses—yet, by letting profits run, you still have the potential to make big money.
A third benefit of a concentrated stock portfolio: You can get in and out of the market more quickly at turning points. Many investors turn bullish on the market and buy a few stocks but, because each stock is just a small piece of their stock portfolio, they're still woefully under-invested. Same goes when the market tops—selling just three out of 30 stocks does nothing, but selling three out of 12 is meaningful.
I could go on, but you get the point. When practicing smart portfolio management with growth stocks, it pays to be concentrated in the market's leaders. So if you're currently holding a few dozen stocks, consider selling the poorest performers, and putting the proceeds in your best performers.
Click here for information on Cabot Growth Investor. Click here for information on Cabot Top Ten Trader.