All of us know about portfolio diversification by splitting your allocations up into different stocks. But recently I read an article on portfolio diversification over time. This is brought to my attention because a trigger-happy investor like me who can’t stop clicking ‘buy-buy-buy’ needs to remember the importance of diversifying over time before I exhaust most of my war chest in a buying frenzy.
For those who have been following the blog, you may have noticed that I can comfortably buy fairly-valued stocks like MasterCard or Priceline or sometimes ‘over-valued’ ones like Linked In. Of course I would be more than happy to buy it at a deep discount to value, but for that to happen, we may probably have to wait for a crisis as severe as the last one. Short corrections may occur over time, but by then, the stock price may have already rose by a large percentage. For example, just look no further at the markets the past few years.
When I started investing in 2010, I could not remember a single day when there was no negative news to scare investors. Currency Wars in 2010. Double Dip Recession Fears in 2011. US Debt Crisis 2013. Fed raising interest rates fears since 2010. Massive printing of money fears since 2010. Oil Crisis 2014 – now. Greek debt crisis since god knows when. And now, crazy gains in the stock markets in China. Peer-to-peer lending bubble. 6 year Bull Market, chances of corrections are higher…. Fear is always rampant.
I remembered once talking to a guy who sat out of the market from 2010-2014, worrying about the massive printing of money and how it will affect the market. He later admitted that he read the situation totally wrong and regretted not investing as per normal (btw, there’s no such thing as a ‘normal’ stock market…) and BTW, the S&P500 has returned about 100% within this 5 years. On the flip side, I have heard of many investors who joined the stock market euphoria in 2007 and could only watch on helplessly when the bear market struck. They did not have any capital left to take buy stocks at a deep discount to their value.
If you happen to be like the examples which I just mentioned, then I pity you and urge you not to make the same mistake again. I also urge you not to be frightened by the media constantly churning out scares for newsworthy fodder. Nobody asked you to dump 100k on one investment, you are able to buy in smaller lots now! Also, if you think you can trade in and out of the markets, getting in on corrections and getting out at the top of bull runs, I urge you to think again. Besides, I am a strong proponent and believer of buy and hold investing. (This blog stands as everlasting proof that buy and hold long-term investing will reap the best returns!)
With that being said, Investors still always seem to be stuck with these decision-making dilemmas:
Do I buy now?
Do I buy later when the price is cheaper?
What if the price never gets cheaper?
Ok, I have decided to buy. But how much should I buy now?
So, the first step is to buy a few stocks/positions and hold so you won’t miss out on growth, (provided of course, that the fundamentals are good.) Next, you can choose to add on to these positions on market weakness or when overblown fears push your stock price down to attractive value points. (Value points = prices that represent an x% discount to the true valuation of you stock price. You need to decide x% yourself.) Again, assuming that the fundamentals of the companies you are investing in are strong – Lower Price=Higher Value.
Instead of making extreme decisions like:
I will only buy when the market corrects 50%!
I can’t time the market so I will buy everything now!
It will be easier to space out your buys over a longer period of time and keep a warchest for bear markets. Again, how much of a warchest do you want to keep? That’s up to your own personal finances. Just make sure it is at a level comfortable enough so that you don’t worry or lose sleep over it. However, the other extreme is when your warchest contains so much cash that inflation slowly bleeds you out. Remember, we do not want to operate on extreme ends of the spectrum for our investment decisions. We must aim for balance in all areas.
A way to space out buying stocks or diversifying over time frames could be as simple as :
I will add on to my positions every 3- 6 months.
I will add on to my positions every 3-6 months but if it is overvalued – I will only add in 1/4 of my free investing cash and tuck the rest away in my warchest
I will add on to my positions if the market corrects and my stock is undervalued by 10-20%, I will add in all of my free investing cash.
I will add on to my positions if the market corrects and my stock is undervalued by >50%, I will dump in all my free investing cash and maybe 1/2 of my war chest.
Every one of us are in different financial stages in our lives. We do not share the same earnings power, cash flow or investment strategies. We do not have the same liabilities, expenses or savings. We do not have the same risk appetites. The key lesson of this post is to approach portfolio diversification not just amongst different stocks, but also throughout different time periods.
Hope I have shown you another way to approach diversification. For newbies reading this blog, please bookmark this post or note it down! I hope I have increased your wisdom by +1, just like how I feel wiser after learning this from other gurus.
I have yet to do a write up for 4 more stocks bought. Like The Bf Gf Money Blog on Facebook or subscribe by entering your email below to receive updates!