Everything in moderation, including moderation
Oscar Wilde
While overall I find this pretty good life advice, it also has applications for personal finance. Here I’ll focus on how you can apply this motto to building your portfolio – though it can also be applied to saving (it’s OK to take that vacation or go to that concert!).
Once you make the decision to invest in individual stocks some generally good advice is to not put all of your eggs in one basket. Build a balanced portfolio and all that. And, for the record, that is good advice, and you will hear me preach it often. However that doesn’t mean you should blindly follow it when you are still in the process of building out your portfolio.
Sometimes fantastic companies go on sale and it creates a once it a decade opportunity to really load up on high quality companies at a price you can almost never get them at. Think 2008-2009. Coca-Cola was trading at $15 per share – a P/E of 13. This is a company that has raised dividends every year for half a century and historically had a P/E in the low to mid 20’s. So we are talking a 50% discount and a starting dividend yield of 6%. 6%! For Coca-freaking-Cola. That’s absurd.
That was in the middle of a financial crisis. Big banks were going bankrupt or needing to be bailed out left and right. There was a lot of uncertainty around stocks in general. But Coca-Cola’s business was doing just fine. It turns out people still need their sugary beverages even during a recession and are still willing to pay to extra few pennies for the name brand instead of drinking something named Bubba Cola or Mountain Lion.
It’s time like that I’m perfectly happy to break the balanced portfolio rule. Unfortunately I was just starting college in 2008 and didn’t really have much in the way of funds to invest. If I was in the portfolio building stage of life then, I most certainly would have been willing to take the risk and build a sizable position in KO.
I am actually a proponent of taking an unbalanced approach to building a balanced portfolio. Say you are just starting out. Maybe you have a list of 5-10 stocks you are excited about, but don’t have a ton of money to save yet. I think using year 1 and selecting what you think is the best value 1 or 2 of those stocks and focusing on them is a great way to go. At the end of year one you may end up with a 100% concentration in just one stock. And that’s OK. Year 2 you can choose a another 1 or 2, and by year 4 or 5, you have what is starting to look like a balanced portfolio.
There are a few reasons I’m partial to this approach. One of the main reasons is unless you are investing in a free or low cost brokerage, the fees for buying 10+ stocks multiple times a year will add up. Another reason is psychological. When you are new to income investing, it is sometimes hard to see the light at end the of the tunnel. You worked hard to save up some money and now you’ve chosen 10 dividend paying stocks to start your income portfolio. For the sake of easy math let’s say you invested $800 in each of your 10 stocks at an average yield of 3%. And you’ve decided to re-invest your dividends.
Every quarter, each of your stocks will pay out around $6. And since companies pay their dividends at different times you get a bunch of random $6’s coming in at different times of the year. Nice, but honestly a low enough amount that can lead to some frustration re-investing, it’s pretty hard to get excited about the 1/8 of a share you are going to receive.
Now let’s say you take the 1 conviction stock route. Now your $8,000 is going into one company. Once every 4 months you are getting $60 to be reinvested. A little more exciting that $6, even though overall it’s the same amount of money being re-invested.
The difference is it is easier to see the compounding effect when you are dealing in larger quantities. Once you and see it and understand how it works for you, it becomes addicting. You want to find another $8,000 to invest in another company and start the process all over again.
If you are able to do that once a year over a 10 year period, you put yourself in a great spot in your income-building journey.