Every year we select stocks right about the time when the summer ends and the kids go back to high school or college. Doing this at the end of the summer gives them time to earn their $500 for the match and sets up a consistent annual pattern for how we make incremental investments.
Due to Stop Loss orders and other sales there is additional money that we need to put back into more stocks. Many of the beneficiaries will have to make more selections.
Diversification and the Number of Stocks in Each Portfolio
As the portfolios get bigger, we also try to pick fewer stocks and put more money into each individual stock. As a rule of thumb you have a “diversified” portfolio if you have about ten or so stocks equally weighted. This only applies if the stocks themselves are diversified, however, across industries and countries. Since most of the portfolios have stocks concentrated in a few sectors or countries, my “rule of thumb” is to try to go up to 15-20 stocks to get additional diversification. At that point if we are buying newer stocks, I will recommend making larger single purchases and we can bring up the average value of stocks in the portfolio.
For example, Portfolio one, which has been growing for almost 13 years, has 17 stocks and about $34,000, with $2000 cash on hand. Thus of the $32,000 invested in stocks, the “average” balance would be just under $2000 per stock. While that is true, we still have a few closer to the $1200 mark and some that are larger than $2000. New purchases will be made in excess of $1500 and as there are sales we will try to keep the portfolio at 20 or less stocks, and even 15 or so is probably about right.
Portfolio Two is also at a level where we have begun consolidating and buying in larger blocks, with 15 stocks, $22,000 invested in stocks, and about $3000 in cash. Going forward we will also be buying in larger lots of $1500 / each and consolidating through stop loss orders and the like.
The other portfolios, three through six, are still at a level where it makes sense to make smaller purchases to get beyond the 10 or so stocks in the portfolio so that if there is a big drop in a single stock it won’t totally dent the portfolio.
Stock Selection for 2014 – Where to Look?
I follow the markets in general due to my line of work in finance and am aware of most sector trends. I have some knowledge of foreign markets and macro economic trends but less so the further you move away from the USA.
I use Google stock screeners to look for stocks in the US and abroad, by looking at stocks with certain market caps (above $1B) and with other characteristics like price performance and dividend yield. Much of the time I am looking for negative performance (i.e. stocks that have declined 0 – 25% over the last 12 months) because I believe that some portion of the portfolio should be tied to “regression to the mean” (i.e. what’s down comes back up) and some on growth stocks.
For foreign stocks I look at those that trade ADR’s in the US, generally on the bigger exchanges (NYSE or NASDAQ). I usually don’t buy ADR’s on the “pink sheets” or OTC markets, although Siemens recently moved away from US accounting and consequently was de-listed from NYSE and picked up on the OTC markets, so I ended up buying one, anyways. I don’t think it will trade that much differently than on NYSE but this is something to watch.
I have a lot of friends in the markets and ask them about stocks or types of areas that they find interesting. Sometimes they laugh at me and tell me everything is overvalued but I usually can get some good ideas.
Barrons and some of the online sources also have interesting information, although I would never just buy something based on a single article. No one should just buy based on something that they’ve seen on the Internet or based on a “tip”.
The standard boiler-plate warning is to “read the financials”. This is true, although slogging through 10-k and annual reports with footnotes can be mind numbing. They have to make so many disclosures of potential risks and there are reams of footnotes and much of this doesn’t directly impact the stock price. On the other hand, I will look at their power point presentations available that the company makes to investors on quarterly calls or conferences where the company actually tries to explain “in english” what their strategies are and why their company is strong (which indirectly goes to valuation). I also will look at various analyst reports on stocks, although once again this is more about sentiment in the market than any particular insight since those reports are often notoriously un-correlated with investor success.
In the end I thing through all this information, pick a bunch of stocks to watch for a while, and then cull this down to my list. Sometimes I even re-recommend stocks’ I’ve previously had on the list, since many of the beneficiaries don’t pick them (if there are 8 stocks on the list often they only take 2).
Valuation is difficult right now with the markets hitting new highs. For an individual, I wouldn’t recommend putting all of your money into stocks (especially individual stocks) like I do in this portfolio. However, this money is different than a standard “nest egg” in that it is an investing vehicle for kids where they put in some money with additional money added that is designed to teach them about saving, investing, and the stock market. It is “real” money and they either win or lose depending on what happens in the market, just like real life. These lessons are sound and something that they will take with them through their whole life going forward.
While the portfolios have benefitted from rising values, they will now be putting money to work on new stocks with high valuations. This cannot be avoided. We will do our best to consider valuation with our new investments, and put in “stop loss” orders on stocks that are getting either too frothy or when we don’t necessarily want to ride all the way down if we’ve had big gains. With this model, however, we do eventually put all the money back to work on new stocks, so overall valuation is always an issue. This is a real-life investing lesson for all.
Timing of the List and Selections.
I will get these items selected in the next couple of weeks and start working with everyone on investing. The kids need to get me a check and the money gets deposited and then they need to make the selection. Everyone comes to the selection in different ways and it can be tough for them to make a decision about real money with real consequences. But this is real life and decisions need to be made, which is a lesson in and of itself. I want to get this done before they start going back to school by the middle or end of August.
The other thing that I have to do before then is update all the portfolios with the latest prices and valuations and dividends, as well as buys’ and sells’. This also takes me a while because I comb through the statements and do it by hand as well as in excel. Maybe someday I will farm out this process or create a system but for now I am doing it manually. Maybe this is a 2015 project. At least with google finance I can see the portfolios daily without doing much work and this is a big help for monitoring moves.