Intro

When I was first getting started in stocks in the early 2000’s, I had about $2000 to my name. I heard that mutual fund investing was a good way to diversify and thus a low-risk way to make money in stocks. So I stuck my entire savings into a telecom mutual fund. Within a year, that fund lost over 50% of its value before I withdrew.

I learned a hard lesson about sector allocation! Don’t put all your eggs in one basket. Or in my case, don’t put all your stocks in one sector.

Over the years I’ve studied investing masters like Peter Lynch, Warren Buffett, Phillip Fisher, and his son, Ken Fisher. I’ve put what I’ve learned to work in my own portfolios. These are a set of guidelines I came up with to keep myself out of trouble.

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In this article, I’m going to cover:

  • Sector Allocation
  • Position Sizing
  • Individual Stock Weighting
  • How Much Cash to Have in a Portfolio?

Sector Allocation

“Thou shalt not hold more than 35% in any one particular sector.”

Here is a list of the 11 Global Industry Classification Standard (GICS) sectors:

  • Energy
  • Materials
  • Industrials
  • Consumer Discretionary
  • Consumer Staples
  • Health Care
  • Financials
  • Information Technology
  • Communication Services
  • Utilities
  • Real Estate

For more info about the GICS sectors, check out www.msci.com or this article on Wikipedia.

Why 35%? It’s a little arbitrary, but I believe that 35% is a high enough percentage for me to reap the rewards of sector I feel strongly about. But it’s not so high that it would completely wipe me out if I were wrong. Remember my telecom fund? Instead of losing 50% of my portfolio, I would have only lost 17.5%.

Warren Buffett is one of the best-known practitioners of focused investing – investing in a limited number of stocks and sectors that you have the most knowledge of. This Seeking Alpha Article states that Warren Buffett’s Berkshire Hathaway holds 37% in Consumer Staples and 35% in Financials.

It appears that Buffett also believes that 35% is a good upper limit.

Position Sizing

“Thou shalt keep my purchases small.”

A general rule of thumb is for investors to risk no more than 2% of their portfolio per trade. By doing so, an investor can make up to 50 bad trades before going broke.

I personally spend up to 4% of my portfolio per trade. Here’s how I usually classify my trades:

  • Initial purchase of a stock in which I have a strong conviction: 3-4%
  • Add-on purchase of a stock: 1-2%
  • Highly speculative stock: <1%

Individual Stock Weighting

“Thou shalt not put more than 10% of principal in any one stock.”

If I believe strongly in a stock, I’m willing to bet up to 10% of my portfolio on it.

Why 10%? Similar to Sector Allocation, it’s a little arbitrary. I believe that 10% is a good enough size to reap the rewards of a stock if it becomes a winner. But I don’t think that’s it’s so much that it’ll wreck my portfolio in case things go badly.

I’ve been tracking Warren Buffett’s purchases of Apple (AAPL) from Q1 of 2016 to Q3 of 2018. Over this time period, Buffett has used up to 14.5% of Berkshire Hathaway’s portfolio to purchase Apple (according to the 13F filings). So why do I set my cap at 10%. The simple answer is that I know I’m not as skilled an investor as Warren Buffett. It would be pure hubris for me to believe that I am skilled enough to make as big a bet as the Oracle of Omaha on a single stock for my portfolio. Therefore, I give myself a margin of safety buy keeping my threshold at 10%.

How Much Cash to Have in a Portfolio?

Warren Buffett famously quoted, “Be fearful when others are greedy, and be greedy when others are fearful.” This is why I think that every individual stock investor should have a cash component to their portfolio.

Here’s how I currently manage cash in my portfolio to take advantage of Buffett’s advice.

  • S&P 500 at all-time highs: 25% cash
  • S&P 500 10% drop from all-time highs: 20% cash
  • S&P 500 20% drop from all-time highs: 15% cash
  • S&P 500 30% drop from all-time highs: 10% cash
  • S&P 500 40% drop from all-time highs: 5% cash
  • S&P 500 50% drop from all-time highs: 0% cash – I’m all in!

What Does Buffett Do?

Warren Buffett wrote in this New York Times article that he was holding 100% U.S. government bonds in his personal portfolio. For all intents and purposes, I consider this the same as cash.

According to the 13F, Berkshire Hathaway held 48% cash equivalents in Q2 of 2006. By Q3 of 2009, it held only 32%. Following his own advice, Buffett started putting Berkshire’s cash to work during the Great Recession.

Summary

So there you have it. Those are some of my most valuable lessons about portfolio management in my nearly 20 years of investing in individual stocks.

What do you guys think? Let me know it he comments section.

Disclosure

I/we have no positions in any stocks mentioned and no plans to initiate any positions within the next 72 hours.

I wrote this article myself and it expresses my own opinions. I’m not receiving compensation for it (other than from Wolves Of Investing), and I have no business relationship with any company whose stock is mentioned in this article.

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