- Asset allocation is at the heart of any portfolio, how you weight your asset allocation is over half of your risk and returns over time.
- ETFs are the best vehicles for building an asset allocation, there are multiple types with subtle difference to be aware of.
- Stock selection is where the potential for high income generation and 10 baggers lie for generating excess returns in a portfolio.
- Careful selection of 12 to 30 stocks can add from several points a year to your total return to as much as double the index averages over time if you are a top 10% investor.
- The key to winning with stocks is avoiding permanent losses and riding your winners until there is a break in price momentum (technical) or a material change to the business (fundamental).
The “Plug & Play Portfolio Stocks” represent investment ideas from our “Very Short Lists” that are near buy zones as of the first week of the new quarter and offer the best upside for intermediate term (6 months to several years) risk adjusted profits.
These are NOT model portfolios to be jumped into right now! There is no such thing. Rather, this is a guide for monitoring your intermediate term position trades (6 months and longer) in stocks.
The “Plug & Play Stocks” can be monitored in a few minutes weekly, with more attention during periods of higher volatility.
Asset Allocation Cash Levels
To make things easy to look at and build towards, you first need to determine who “invested” you will be in the short-term. Because we do not all have the same financial circumstances or risk tolerances you must first decide if you want to be fully invested right now.
So, the first question for you to answer as you build your portfolio is this:
How much of your investable assets do you want invested right now?
Each Plug & Play piece will have a set of cash levels for you to consider holding in the short-term (weeks to several months). For lack of more creative words, I call these levels:
- Defensive – for those who are willing to miss short-term gains due to concerns about market risks.
- Cautiously Optimistic – for those who want to make most short-term gains, but want to keep some dry powder for “black swans.”
- Pedal To The Metal – for those who want to almost all-in, almost all the time, and can tolerate high volatility.
Sample cash ranges:
|Investor Category||Defensive*||Cautiously Optimistic||Pedal To The Metal|
|Current Cash % (Tactical)||50-40||30-20||15-10|
|Long-term Cash % (Strategic)||12-4||4-2||2-1|
* It is very rare that even Defensive investors would ever be more than half in cash. Typically 40-50% cash is the most any investor should ever hold. Occasionally, a few times in life when there are great unknowns, an investor might go 75% cash. However, this should be based on the possibility that your standard of living could be threatened by an event, not that you are trying to predict things or are just fearful. In those situations, we must be humble and control our emotions.
We must remember that stocks tend to go up the longer we hold them. Thus, we should always try to find a way to gravitate to our long-term strategic cash levels, regardless of our fearfulness of the unknowns.
Investing Strategy Thoughts
Most people will build their core asset allocation around ETFs. Or, you will have other assets, such as a 401k that serves as a more diversified portion of your overall total portfolio. In general, you will want to select 12-30 stocks to add to your diversified core.
There is a good chance that your stock (including REITs) selections will not be very diversified. That is why having a diversified core to build around is important.
For most people having a diversified core, whether ETFs or 401k or both, is a great idea. Having rough split of 50/50 diversified core portfolio and then less diversified stock holdings is a good mix. 75/25 and 25/75 are fine depending on your goals and risk tolerance.
Strategic Investing vs Tactical Trading
Strategic investing is the long-term asset allocation that you will gravitate towards. The Plug & Play Stocks quarterly update is concerned with intermediate and long-term strategic “position trades” lasting 6 months or longer.
Tactical trading, or swing trading, is the shorter term (under 6 months) trades that you can make to take advantage of market conditions. Sometimes these shorter term trades last longer, but for the most part, tactical trades last a matter of months.
If you are going to make tactical or swing trades in stocks, then make sure that you make trades that if they don’t work out short-term, avoid permanent losses and can become good longer term investments if you can’t sell quick enough to avoid short-term losses.
Scale In, Scale Out
Make sure to mind the buy zones and scale in at 2 or 3 support lines as marked by our broad (yellow box) buy zone and narrow (orange box) buy zone.
Areas where Fibonacci lines bunch up are called ares of confluence. These are generally strong support or resistance areas.
Technical indicators, particular weekly RSI and the volume profile also offer very strong indicators of market trends and strength. Make sure to read our Technical Trading Basics: Using Overbought And Oversold Signals To Buy And Sell.
When buying or selling, you want to do so incrementally, i.e. scale in, scale out. This is important to manage risk, as well as, ride winners for greater profits.
By scaling in you reduce your need to be perfect. It is a form of dollar cost averaging, but instead of using the calendar, you are using price levels. In general, buy at 2 or 3 levels within the broad and narrow buy zones, i.e. at 2 or 3 of the yellow or orange lines.
Scale out to reduce your need to be perfect. Scaling out helps to manage risk, but also leaves some money participating in a winner that is gaining. There is merit to the phrase “let your winners ride.” There is also merit to “taking profits.” Scaling out allows you to do both.
The Main Reason To Buy Stocks
The main reason to buy stocks directly is to add extra upside to your portfolio. Because of that, there is NO REASON, to buy stocks that you can not surmise have a substantial chance to beat the markets by a substantial margin.
There is NO REASON to take single stock risk for any “good idea” stock that does not have a reasonable chance to beat the stock market by at least double or triple. We need that potential to offset single stock risk.
For growth investors, looking for stocks that can offer a total return that can lead to annualized returns of over 25% is a reasonable goal and good target for taking single stock risk. We accept higher risk for the chance to find higher returns.
For dividend investors, looking for stocks that can offer a total return that can lead to annualized returns of around 15-25% is a reasonable goal and good target for taking single stock risk. We accept the potential for doubles in return for lower risk that what growth investors accept.
Obviously, the likelihood of always achieving such high returns is low, however, by setting the bar high for taking single stock risk, we manage our overall portfolio risk and give ourselves opportunities to add alpha to our portfolio. This is the type of discipline that creates strong risk adjust returns for the long run.