It's always great when a stock you own does well. Then does even better. Watching it go up and up is one of the pleasures of investing. There's a feeling of well being that comes from watching your portfolio grow. But as we all know, nothing goes up forever. And when there's a huge pullback in the market, that sickening, empty feeling that goes with a stock crashing completely overwhelms the moments of pleasure experienced on the way up.
So investors need to keep a balance. It certainly helps in life. But it's just as important in portfolios. Too often, portfolios are allowed to grow like an abandoned garden, untended, and never trimmed. When that happens to stocks, good things rarely follow.
Some investors wait for the end of each month before they look at their portfolios. Then, if the number is bigger than the month before, they go on to other things. The next month, they do the same thing. Until one month, the number isn't bigger. It's much less bigger. In fact, the gains have turned to losses. Then they take some time and look at what happened.
Usually what happened is that one stock took a dominant position, had a great run up and took the rest of the portfolio value with it. Other stocks went down or barely moved, but the overall net worth keep going higher because one stock enjoyed a great run.
Other investors work for solid companies and own stock in them. Sometimes, those holdings are the majority, the vast majority, of their net worth. Since they see every day how the company is doing (or at least they think they see), they think they know what a great investment they've got. Besides, even if there are one or two bad quarters, they have complete faith in management and believe things will turn around. Many times they don't.
All investors need to keep a balance, whether they're CEO's or retired. Stocks are risky. They are volatile. They can go down much faster than they go up. Unless your portfolio is adequately diversified, you're opening yourself to major pain, to your wealth, and even to your health.
When stocks drop dramatically, and we all know they can as we lived through 2008 and early 2009, there's a sickening feeling that goes beyond mental. And it's much stronger than the euphoria felt when stocks go higher.
Making profits in the stock market is hard. They can disappear quickly. (See Dendreon, DNDN, as an example of a stock demonstrating the fast disappearing profit act. There are many, many more examples. Maybe one you've owned.) Investors can shield themselves somewhat by making sure portfolios are not over weighted in any one stock (yes, even their company's stock), and by owning much more than just stocks and bonds.
Or at the very least, if your portfoio is only stocks and bonds, then they need to be rebalanced every month or quarter or year, whatever time period gives you comfort.
Allocation of 5% to any one stock can usually keep a portfolio out of trouble. It could be less or more, depending on your level of risk. The higher the percentage, the more risk you take. Also, important is the number of industries or sectors represented. If all stocks are banks and thrifts and insurance companies, then there's no diversity. The whole portfolio is dedicated to financials. There's a need for balance among several industries and sectors as well as the number of stocks.
Don't keep riding the same rocket. Even the best of them run out of fuel. Or if you're lucky, they simply stay in orbit without going anywhere after a while. Look to balance your portfolio on a regular basis. It helps your wealth. And your health. And to truly balance your investments, you need to go beyond stocks and bonds and into other asset classes.
- Ted Allrich
April 3, 2012