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The 20% Solution Can Mean Millions for Your Portfolio

By: Andy Obermueller
Posted: 6/14/2010 1:02:00 PM
Referenced Stocks: GE

Today I'd like to introduce you to my friend Mike. Mike is a real person and that is, in fact, his real name. He and I met in college and have been close friends since. He's extremely intelligent, a partner in a major law firm, and he has, to my knowledge, never bought an individual stock.

Mike and his lovely wife are very risk-averse. They're both leery to the point of paranoia about stocks, and they resolutely despise the remotest prospect of losing money. Their portfolio is remarkably conservative. It's mostly cash.

I've told Mike until I'm blue in the face that knowledge mitigates investment risk. I've repeatedly shown him ways to limit his downside. And, frankly, I have a very strong track record of picking stocks, a spate of winners that ought to enhance my credibility and nudge him toward action. But none of that matters. He isn't going to change.

It's going to cost him.

If Mike were to open a savings account with $50,000 and add $1,000 to it each month, he would rack up $306,994 in twenty years. That's not chump change, but his total earnings would be a mere $16,994. Over the course of that long period of time, the rate of return offered on FDIC-insured savings accounts wouldn't even make up for inflation .

In the long run, it is almost guaranteed that Mike is actually going to see his worst fear come to pass: Without a stronger return, he'll lose money.

My buddy Jeff is a P.R. genius in Dallas. We were neighbors in school and have been close ever since. Jeff and I talk a little more about investments than Mike and I do, and Jeff isn't afraid to put money into the market, though his idea of investing is to find a good S&P index fund with a really low expense ratio , park some money in ultra-safe bonds and let both investments sit as he reinvests his gains. It's not a bad strategy, but it does mean that he will settle for less than the overall market's return every year.

If Jeff starts investing today with a $50,000 portfolio in such an index fund and adds $1,000 a month, then, based on historical averages he and his wife will capture $492,191 in gains in 20 years, which will give their account a balance of $782,191.

Both Jeff and Mike are extraordinarily talented, and each has an admirable work ethic. In other words, Jeff and Mike have exceptionally strong earning power.

But even with six-figure salaries, a few big bonuses and generous retirement plans, I'm sad to say that neither of these two friends of mine is on track to use his money to build a multimillion-dollar portfolio.

That puts them in the same boat as just about everyone else, of course. Most investors are stuck in the slow lane, passively accepting the market's returns and failing to use equities as the supercharging force they can be.

Before I go any further I should tell you something about the cash Mike hoards and the ho-hum securities Jeff prefers.

There's nothing wrong with them. Not a thing.

In fact, every intelligent portfolio should contain some of each. But, at the same time, a portion of ANY portfolio that's aiming for seven figures has to swing for the fences. I'm not saying it needs to be "high risk." It doesn't have to involve complex derivatives, dicey junk bonds or commodities. The securities allocated to this segment of the portfolio simply have to have the potential to deliver serious gains.

I'm a father of a daughter who's in private school, will go to college and who will need cars, trips and someday, a wedding. I'll tell you this about my portfolio: It's got a lot of choices that Jeff would like. About 80% of these assets, in fact, are blue chips like Berkshire Hathaway (NYSE: BRK-B ) and General Electric (NYSE: GE ) . They offer the prospect of a reasonable return over time, and neither is so risky that I worry about risking my daughter's future.

But the other part of the portfolio? I call it the "20% Solution."

These securities are what I'm counting on to make a major difference in my returns. I know that these companies have the potential to deliver huge returns. One such stock has already returned more than +200% in the past year, and the fact is I wouldn't sell those shares if you put a gun to my head because I think they are going to keep rising. In fact, when I add money to the portfolio each month, it's the first company I consider adding shares of.

Over time, big winners like that are going to move the needle on my portfolio. They're going to make some dreams come true, and to make sure that happens I allocate a small percentage of my portfolio to them.

It works like this:

Say you have a portfolio with the same starting balance of $50,000 that Mike and Jeff had in my two examples. If you allocated 80% of that to the S&P and invested the remaining 20% of the money into a stock that delivered knockout returns, the picture changes dramatically. From 2000 to the end of 2009, S&P dropped more than -20.0%. If you had a portfolio exposed to broad market returns, you lost money. In the case of the S&P, that $50,000 would have shrunk to $39,983.20.

If you'd allocated 20% of the portfolio to shares of Apple (Nasdaq: AAPL ) , however, you'd have ended up with $113,224, as the computer maker's +712.4% on your $10,000 in the period offset -$8,013.42 in losses on the $40,000 allocated to the S&P.

Using the compound annual growth rate for Apple and the S&P 500 during that decade, we can observe the difference between the two portfolios as the $50,000 grows with the addition of a $1,000 investment each month.

The S&P 500 Portfolio, to which a total $170,000 was contributed, incurred a -2.21% compound annual loss and ends up at $148,729.

But the S&P-Apple 80/20 portfolio, which also saw $170,000 in contributions, sees a dramatically different turn of events as Apple, despite its minority position, generates a huge disproportionate return. Eighty percent of the portfolio, the initial $40,000 plus 136,000 in additional contributions, is allocated to the S&P and shrinks to $118.984. But the Apple shares, which start out with $10,000, or 20% of the portfolio, and to which an additional $34,000 is added, grow to $154,567, for a total balance of $273,551, a +60.9% total return.

That's the power of a game-changing stock like Apple.

And those are the kind of stocks I focus on finding. In a number of cases, I've found stocks that offered triple-digit returns in a far shorter period of time. I captured a nearly +300% gain with Rockhopper Exploration in less than 90 days as that small oil exploration firm made a major discovery in the South Atlantic -- sparking an international diplomatic incident in the process.

Another game-changing Apple-like company I discovered is a tiny enzyme maker with a huge presence in the biofuel arena. It's delivered a nearly +200% gain in the past year -- a rate of return that blows the doors off the +23.3% annual growth rate Apple achieved in the example.

What I'm saying is that the results of a portfolio with room for big winners can be dramatically different from those that stick to cash, fixed-income or even the returns available in the broad market.

As I can continue to uncover the fast-track picks like the ones I've already found, I'll inch closer to a multimillion-dollar net worth in a relatively short period of time.

The point is this: The returns provided by 80% of your assets will be materially insignificant. They almost don't matter at all. It's the big winners that propel the portfolio, not the same blue chips that everyone else is investing in.

So, clearly, the question is how investors can find those picks. It's an important topic. I've got a six-year-old little girl whose face I see in my mind when I think about just how important those returns are. And to help you find fast-track picks for your portfolio so you too can position yourself for supercharged results, I'm launching a new publication called Fast-Track Millionaire For a sneak peek at this exciting new letter, please join me for a free webcast on June 15, where I'll reveal some of these game-changing companies and try to help put you on the Fast Track to wealth!

Andy Obermueller
Editor: Government-Driven Investing, Fast-Track Millionaire

Disclosure: Andy Obermueller does not own shares of any security mentioned in this article.