Thanks for another informative blog. It would also be beneficial if you can post a topic related to portfolio sizing i.e. how you build a position in any stock, weighting of those individual positions, is there any maximum allocation strategy you follow etc

In this article, I want to address this comment as this comment forced me to think about my portfolio building strategy. My investing portfolio has two legs. Index Funds and Individual Stocks. Index Funds are one of the most beautiful, passive investing strategies out there. Every month, I dollar-cost average into these six funds regardless of the direction of the stock market. It does not matter if the market is up, down or sideways. 

For individual stocks, my goal is double my portfolio every five years (approximately 15% annual returns).  I measure these returns over five years. In other words, if I am down in a year, that does not bother me because my goal is to generate long-term returns, not annual returns. If you have read my articles, you already know that stocks do not go up in a straight line. For context, here are the returns of the last four years on my individual stocks portfolio

 

Year Annual Returns
2017 43.00%
2018 1.47%
2019 32.97%
2020 156.81%

 

2020 was an outlier. I have never seen anything like this in the last decade that I have been investing in and I don’t expect to repeat results like this. 

I am extremely selective when I decide to buy the stock of an individual company because I want to follow the quarterly results and any additional information about each of my companies. That research takes time. Therefore, an ideal portfolio size for me is about 15-20 companies and out of those 20 companies, the top 10 companies will make up about 75% of my portfolio. These are the companies which I have the highest conviction in. 

When I start a new position after doing my research, I will usually buy 0.5% of my portfolio. I call this a starter position. This will force me to learn more about the company, their business, management and if they are doing what they say in their quarterly statements. Depending on their business execution I will gradually increase my position to 3-5%. On the other hand, if I see any performance issues or I come across something that is a red flag in my opinion (management, culture, execution issues, accounting issues), I immediately sell out of my position regardless of the share price. I don’t wait for the share price to get even. I just take my dollars and move into a new position. 

I like to see a business executing well before I add more dollars to that position and usually if a business is executing well, its share price would follow but that is not always the case. I do pay attention to the stock price but don’t make my decisions solely based on the share price. By itself, share price is just noise. 

There are various ways to run a portfolio. Some people like to run a well-diversified portfolio of 30,40 even 50 holdings. When I started investing, I was doing that as well. I wanted to buy every stock that had a good run up because I had FOMO (Fear of Missing Out). 

Later on I realized that it was impossible for me to keep an eye on more than 20 holdings. I also learned that I don’t have to be right about the stocks that I do not own. I only have to be right about the stocks that I do own.

Now, at the end of every month, I do an exercise where I line up the top 10 positions in my portfolio and give a serious thought whether this is what I want my top 10 positions to be. If you have never done this exercise, I strongly encourage you to do so. You might find that a stock that you are really bullish on represents only 0.5% of your portfolio. On the other hand, a stock that you are not so sure about represents a much higher portion of your portfolio. So, even if that 0.5% stock quadruples from here, it will still be a 2% position for your portfolio and it may not move the needle.

By forcing myself to not exceed 20 positions, I treat my portfolio like a sports team, where the top 10 positions are like starters and the bottom 10 positions are like the bench of a sports team. Every month I add new money to my portfolio and I allocate based on my conviction in each company.

When to Sell?

If a company is executing well, buying and adding to that position are easy decisions. When to sell is a very hard decision for me. I rarely sell because the valuation has increased. In fact, I look to add when the stock has run up. That usually means that the business is performing well. I sell

  • If I need the money in the next three years. For example, I trimmed some of my winners this year because I need the money for a project (Amazon, Tesla, Netflix, PayPal, Atlassian)
  • If a business fails on execution. For example, my sells in the past couple years. Alteryx, Nutanix
  • If I find a company that I like better than my current holdings. I do this once a year or so. This does not work well many times. For example, in the past few years, I have sold Workday, HubSpot and Shopify. Yes, Shopify!! Look at the price chart of Shopify to see what a mistake that was. 

Selling a holding because it is not performing according to my expectations does not always work well, because sometimes, the best companies go through a period of consolidation when the stock price does not move while the business is performing really well. For example, Tesla stock price stayed range bound for six long years before it took off in 2020, while the business was doing really well in those six years as Tesla introduced a slew of new models. 

I wish I could say that this process is perfect and I have had the best results following this process. However, as I mentioned selling Shopify above, my results would have been even better if I did not sell Shopify. I am still learning and tweaking my  process and have come up with a strategy that seems to be working well for me. This blog and putting my work in writing has helped me immensely in this process. 

Do you have a process? How many stocks do you hold in your portfolio? When do you buy? When do you add to your positions? When do you sell? 

Feel free to comment below.