Portfolio Weighting and Portfolio Turnover

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Portfolio Weighting and Portfolio Turnover

The weighting is the hardest part

In addition to knowing how many stocks to own in your portfolio and which stocks to buy, the percentage of your portfolio occupied by each stock is just as important. Unfortunately, the science and academics behind this important topic are scarce, and therefore, portfolio weighting is, again, more art than science.

We do know that the great money managers have a knack for having a greater percentage of their money in stocks that do well and a lesser amount in their bad picks. So how do they do it?

Essentially, a portfolio should be weighted in direct proportion to how much confidence you have in each pick. If you have a lot of confidence in the long-term outlook and the valuation of a stock, then it should be weighted more heavily than a stock you may be taking a flier on. If a stock has a 10% weighting in your portfolio, then a 20% change in its price will move your overall portfolio 2%. If a stock has only a 3% weighting, a 20% price change has only a 0.6% effect on your portfolio. Weight your portfolio wisely. Don’t be too afraid to have some big weightings, but be certain that the highest-weighted stocks are the ones you feel the most confident about. And of course, don’t go off the deep end by having, for example, 50% of your portfolio in a single stock.

Portfolio turnover: do it with care

If you follow the fat-pitch method, you won’t trade very often. Wide-moat companies selling at a discount are rare, so when you find one, you should pounce. Over the years, a wide-moat company will generate returns on capital higher than its cost of capital, creating value for shareholders. This shareholder value translates into a higher stock price over time.

If you sell after making a small profit, you might not get another chance to buy the stock, or a similar high-quality stock, for a long time. For this reason, it’s irrational to quickly move in and out of wide-moat stocks and incur capital gains taxes and transaction costs. Your results, after taxes and trading expenses, likely won’t be any better and may be worse. That’s why many of the great long-term investors display low turnover in their portfolios. They’ve learned to let their winners run and to think like owners, not traders.