Ask Doc The education of new investors often follows a similar path...
They get interested in the stock market. They think it's just a matter of time before they find some small, unheard-of company that will grow 100 times over, making them rich.
Before long, they realize that investing in small companies is harder than it looks.
Yes, occasionally a tiny stock blossoms into a big winner...
But if you don't have a strategy for choosing the right small companies, it won't be enough to offset all the duds.
Eventually, investors usually learn that the "easy way" to succeed in investing isn't speculating on which small company will take off... but to buy established quality companies and hold them for extended periods.
This method of investing is near and dear to me. In my Retirement Millionaire flagship letter, we focus mostly on blue-chip dividend payers... companies with well-known brand names... and funds with plenty of liquidity.
We love their safety and ability to compound wealth over time... We built our portfolio around them.
Recommending these large companies and funds is the best way that I can serve my subscribers. It's how we ensure that everyone can buy in at a good price.
And yet... small-cap stocks consistently outperform large caps over time.
It makes sense that small and growing companies can be spectacular investments. It's much easier for a company with $10 million in sales to grow sales and profits than it is for a large company that already dominates its market.
When you compare the returns of the S&P 500 Index (which is all large caps) with the returns of the S&P 600 Index (a collection of 600 small-cap stocks), you can see that small caps often outperform...
This type of "going small" strategy is a huge advantage that you have as an individual investor... if you're willing and able to do the extra work.
It's not easy to find small companies with strong growth prospects. You have to uncover their niche... research management... study the debt structure... weigh competition risks... and identify whether their growth is sustainable.
But this difficulty means lots of investors aren't paying attention to the right kind of stocks today...
According to my friend Marc Chaikin, a much larger and wider variety of stocks in the market is going to participate in this bull market going forward.
But the biggest winners, by far, are not going to be stocks like the "Magnificent Seven" that have been largely responsible for the market's gains up till now.
They're going to be a group of stocks that almost everyone is ignoring.
On Wednesday, Marc detailed the straightforward investing approach that...
- Historically outperformed the biggest and most popular stocks nearly fourfold since 1966...
- Could beat the S&P 500 fourfold over the next year based on a signal that has been 100% accurate since 1943...
- And amplifies the impact of the bullish signals he sees using his stock-rating tool, the Power Gauge.
If you missed it, you can catch Marc's entire presentation – for free – right here.
Now, let's dig into the Q&A... As always, keep sending your comments, questions, and topic suggestions to [email protected]. My team and I really do read every e-mail.
Q: Hi Doc. Will you recommend a formula or a percentage to start taking profits on stock gains? For example, sell 20% of position when stock is up 50% from your buy price. Thanks. – B.V.
A: Thanks for being such a loyal subscriber, B.V. Longtime subscribers know I like to hold blue-chip stocks for the long term. For example, I first recommended folks buy Microsoft (MSFT) back in 2010. And we're up more than 1,400%. Microsoft is the kind of company that will likely be around for decades – a classic sleep-well-at-night investment. So this is a case where you can just let you winner ride.
What do should pay attention to is how much of your portfolio a position takes up. For anyone who doesn't know, I recommend subscribers put no more than 4% to 5% of their portfolio in any one stock. And more speculative positions should represent even less. Then I recommend using stop losses that tell you when to sell – typically 25% below your entry price (called a hard stop) or 25% below the position's peak price since you bought in (a trailing stop).
With a 5% position size and a 25% stop loss, the most you can lose on any single stock is around 1% of your entire portfolio.
If you invest in funds, you could consider a larger position size of up to 20% of your investment portfolio. That's because funds are already diversified within the class they invest in.
But whether you're invested in either an individual stock or a fund, your portfolio's makeup will change over time as different positions move up and down at different paces.
That's why I recommend reevaluating your portfolio at least once a year. If you notice a stock is taking up a large portion (say, 10%) of your portfolio, sell part of it to get back closer to the 5% mark. Then, you can put your money to work and try to do the same thing over and over.
Selling doesn't mean it has become a bad investment. It's just a way to protect yourself from having too much of your money in one place and suffering from the risk of a larger loss if that investment were to fall.
Look at your funds the same way... When a single fund takes up more than 20% of your portfolio, consider scaling back and reinvesting the proceeds into other positions.
What We're Reading...
- Did you miss it? You should be questioning today's hottest stock.
- Something different: Clues behind why the woolly mammoth went extinct.
Here's to our health, wealth, and a great retirement,
Dr. David Eifrig and the Health & Wealth Bulletin Research Team
June 28, 2024