One of the best pieces of advice I ever got in a book came from Spooner’s Do you Want to Make Money, or Do You Just Want to Fool Around? Spooner pointed out that a big mistake many people make is not buying enough shares of a stock they like. They may do great research, pick a great stock, and buy at the right time, but they buy so few shares that what should have been a big winner turns into a nice but modest gain.
For example, they may buy 100 shares of XYZ corporation at $20 per share. If XYZ does really, really well it might be at $60 within a year. Our investor picked a great stock – up 200% in a year! And yet, our investor made $4000. Not really life changing.
Spooner instead recommends buying 500 shares or even 1000 shares. This would be a large position in our $20 stock – now $10,000 or $20,000, but the same 200% gain would be a gain of $20,000 or $40,000. Something that would make a difference when compared to other income. A good stock pick could be a new car or tuition at a state university. It could be a new kitchen or a boat. (Boat = a hole in the water people throw money into.)
I looked at my portfolio and found that I was doing just what Spooner said. I had several 100 share positions. Whenever I made $1000 I would sell and be glad. I would also have the occasional $2500 winner, but there were also some $800 and $1500 losers here and there. At that point I decided to become more serious about my investing and buy larger positions.
Now I tend to concentrate my individual stock picks in a few, larger positions. If I want diversification, I may then allocate a portion of my portfolio to index funds. For example, if I had $40,000 to invest, I might put $15,000 into an index fund or two and then buy maybe 500 shares in three stocks in the $20-$25 range. I would pick stocks in different sectors, for example, retail, technology, and healthcare, and pick what I considered to be the best stock in that category.
I would get into these stocks in stages. I might buy 200 shares at first, then wait a few weeks or months, waiting for a good dip. Then I’d buy another 200 shares, and then do the same thing for the final 100 shares. I might be watching all three stocks, buying the one that looked the best during a given time period. This way of wading in helps out psychologically since if I buy a stock and it goes down, I think “Great – it’s at a discount!” instead of “Whoa, did I screw up?”
I am then at an advantage to the mutual fund manager. I can pick my top three stocks because I only have about $25,000 to invest. The manager has a couple billion to invest so he needs to buy all kinds of stocks he really doesn’t like. I can also sell a position when I want without worrying about effecting the price. The manager may take weeks to unload a position since he has so many shares to sell.
Now before jumping in with both feet, realize the risks. If I pick badly, like the CEO takes all the corporate money and goes to Mexico, I could see my $20 stock crater to $2 and lose $9000 of my $10,000 position. Even if I just pick a stock that sits there for ten years, I may give up all sorts of appreciation that I would have gotten if I had just put the money in index funds and tracked the market.
I accept this risk, however, since there is a large potential payoff and I could sustain a loss of $9,000 without jumping off a building. My rule of thumb, however, is to never have more in one position than I could stand to lose. If I did well and saw a position grow to $40,000, I might very well sell half of the shares. I would also keep saving money and buying more shares, adding additional stocks when the positions reached 500 or 1000 shares.
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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.