Let’s start with what portfolio management means. In the simplest form, this is about investing in a group of assets (in this case we’re focused on stocks) while following principles around asset allocation, diversification and rebalancing.
Portfolio Management corrects for bad habits of over-allocation into a single position. However, for traders who like the thrill or the idea of making a massive return from 1 single trade, portfolio management restricts that. For me, this is a fantastic thing because I don’t believe in crystal balls.
Everyone builds a thesis or a reason for why they invest in a stock (or at least I’d like to think so). Who knows, some folks might literally just be throwing a dart and taking a bet. At the end of it all, I believe we are all at the mercy of the market. Everyone wants to hold winners and multi-bagger stocks, but holding losers is inevitable. When your stocks are up, it’s very easy to tell yourself you should’ve allocated more, but I am certain that if your stocks were down you wouldn’t say that you wish you allocated more. So that begs the question, how sure are you that your investments will go up? I am going to call BS if you tell me you have a crystal ball. You can have a very strong investment thesis, and if everything that needs to play out does, the market should price the stock in your favor, however there are so many factors outside of your control that there is no way you can with 100% certainty say each stock you pick will generate a return and also tell me how much. If you’re not 100% certain, then why bother with a guessing-game approach and instead just not follow a disciplined portfolio management investing approach? You’ll be in the game a lot longer.
Asset Allocation: Invest no more than 5% of your capital into a single position. This means 20 stocks in your portfolio with varying allocations that should be connected to your investment thesis for each stock, your conviction for how well the stock could perform and the level of risk you believe could materialize. If you are allocating slightly more into a position, for the same reasons above, make sure you are aware of the strength behind your investment thesis.
Diversification: Consider stocks across sectors. This adds protection as different sectors go through economic cycles on varying timelines. There are mathematical models you can look into if you want to get really technical on minimizing the covariance of your portfolio. On this point, also consider the volatility of the stocks you’re investing in. This can only be determined historically, which is not a gauge of what may happen in the future, but it is still very useful to know.
Re-balancing: As your portfolio and each position changes in value, make sure you are constantly reviewing your investment thesis for each position and rebalancing to either take profits or cut losses as you evaluate whether the investment thesis still holds. There will always be new opportunities to allocate capital towards.
Why is Portfolio Management so great?
- It forces you to be disciplined.
- This discipline prevents over allocation of capital into any single position and de-risks your portfolio from emotional decisions and poor asset allocation habits.
- It keeps you in the game a lot longer, and makes you think long term about the stocks in your portfolio. You start to review stocks from a fundamentals standpoint. Why bother putting 5% into a stock that has a mediocre chance of generating you a return?
- Allocating at most 5-10% of your capital into a single position reduces the risk of your overall portfolio and forces you to be selective about what stocks go into your portfolio. You will want the best of the best to make sure each stock is pulling its weight.
Seeing your investment portfolio do its job is a beautiful thing. Think of it this way, it’s been said that if you want to go fast, go alone (1 stock), if you want to go far, go as a team (multiple stocks). Your portfolio is your team of stocks, hand selected by you to perform as a collective unit. You are their leader and responsible for the portfolio’s success. Some stocks will exceed your expectations, and some will fall short. That is okay, as long as your team of stocks as a whole continues to get stronger.
Investing with a portfolio management approach can be boring. It’s definitely not as exhilarating as being overweight on a stock that you’re making boatloads of money on, but on the flip side you’ll never be taken out if 1 or 2 positions move massively against you – you will stay in the game.
Once you begin to focus on refining and improving your investment approach (the thing that you believe gives you an edge), your portfolio stands that much better of a chance to generate even stronger returns as a whole, all while continuing to minimize your risk.