When should I sell a portion of a stock position? How much is too much to have in a single stock?
If you want to beat the market, you wish to concentrate money in the best companies you can find, rather than buying the companies you like as well as a lot of other companies that you do not like. Note that this is if you are investing based on the fundamentals of the company. You are buying the most promising companies, based on their balance sheets, prospects, and future earnings growth. This is different from just trying to picks stocks that will do well in the next few weeks or year which is good for entertainment but won’t result in any serious growth of wealth. In that case it makes sense to spread out the funds since you are basically just leaving things up to luck and it is better to reduce your chances of losing a lot in any one position.
When you are young with a long time horizon but little money, you can afford to concentrate in a few positions. As you get older, have some money to protect, and will need the money soon, you need to diversify into many companies (or probably a set of index funds or mutual funds). For money you’ll need within the next 5-10 years, putting funds into a money market or a CD might be the way to go instead of investing in stocks at all since there is no guarantee of the value of the account within such a short time period.
In both cases, the bottom line is that you should put just as much money into any single stock position as you would be willing to lose. If you only have $2000 to invest, you could probably afford to lose the whole amount so it would make sense to just take up one position. If you have $100,000, however, you might decide that taking 10 positions, such that the most in any single position is $10,000, might make more sense. You might also wish to put some funds into mutual funds or index funds and accept a slower growth rate in exchange for more security. If you also find you are a terrible stock picker, or simply can’t bear the thought of losing your full investment, the mutual fund or index fund route might be for you as well.
As you continue to invest and have some winners, the value of single positions will grow. If you stick with the rule of not investing more than you would be willing to lose, you will be selling shares of companies that have performed well periodically and investing the money elsewhere. In this way you lock in gains and protect the assets you have acquired. If a portfolio becomes truly large, diversifying into real estate, commodities, and other investments makes sense as well.
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Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing