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With Stocks, Resist the Collecting Mania
A Well-Managed Portfolio Should Be Carefully Selected, Diversified
In the play (and film) Amadeus, Emperor Joseph II and his sycophantic courtiers admonish the young Mozart for employing “too many notes” in his latest composition. Mozart is aghast at this criticism, explaining that his work uses only as many notes as are required, no more and no less.
Investors and clubs use several strategies to keep the risk in their portfolios at a manageable level. Analyzing stocks with tools such as the Online Stock Selection Guide or Toolkit 6 to find high-quality, well-managed companaWhere investment clubs are concerned, however, many of them certainly do own “too many stocks,” and this puts their portfolios at risk of underperforming the market.
Most experts agree that somewhere between 15 and 25 well-selected, high-quality stocks, spread over a minimum of six or seven industries, provide the best benefits of diversification.
Too few stocks, and your portfolio could be too adversely affected by the downfall of a single company. Too many stocks, though, and your returns will edge closer to that of the overall market and reduce the chance of besting the averages.
Here are a few guidelines for avoiding the discord that arises from owning too many stocks in a club:
• Invest in no more stocks than your club members can manage to follow. Each member is responsible for serving as stock watcher for no more than two companies, presenting news and recommendations about those stocks at each meeting.
• Eliminate industry overlap. There’s little point in owning two companies in the same (or closely related) industry group. Stick with the best of the bunch and don’t try to “split the difference” by owning two similar companies.
• Set a policy for the minimum dollar amount the club will invest in new positions. A good rule of thumb is to invest only when commissions will be less than 1 percent of the total amount of each investment. This may mean that it could take several months before you have enough cash to buy a new stock, and that’s fine — use the time to research and dig deeper into potential holdings.
• If you find a terrific-looking stock, consider replacing an existing holding — especially one that may be performing poorly — instead of simply adding it to your portfolio. Even if you have the cash, remember that you’re building a portfolio, not collecting stocks.
• Rid your portfolio of “shards.” These are small positions in companies, usually acquired as the result of a spinoff, to pacify a member or to test the waters with a tiny purchase. In any case, a stock that makes up less than 2 percent to 3 percent of the club portfolio should be reviewed and then either dumped or repurchased. These shards take up too much of the club’s attention and because of their small value won’t contribute much to the club’s return even if the stock performs exceptionally.
• Only add a greater number of securities as your club exceeds $100,000 and beyond. This is partly psychological — a 40 percent drop in a stock that makes up 7 percent of a $50,000 portfolio is $1,400; meanwhile, the same percentage decline in the same stock that accounts for the same percentage of a $500,000 portfolio is the price of a new compact car. The change in magnitude can make it hard to act rationally, so it can be wise to increase the number of stocks owned to spread the risk around a bit further.
That being said, remember: Concentrating your portfolio holdings in fewer companies is one of the keys to more harmonious club operations.
Douglas is ICLUBcentral's product manager, helping develop the company's programs including Toolkit 6, myICLUB.com, and the Investor Advisory Service. He is also the author of several investing books, including The Pocket Idiot's Guide to Direct Stock Investing, The Complete Idiot's Guide to Online Investing, The Armchair Millionaire, and Investment Clubs for Dummies.