Did you ever watch a school of dolphin or porpoise as they follow closely beside a boat? Of course, no single one can stay two feet in the air all the time; but, each rises from the water, arches gracefully above it for as far as he can propel himself, and then knifes back into the sea. Shortly after the first emerges, another does the same, and then another. And so on. The effect is that, at any one moment, a number of the graceful animals are above the surface, glistening in the sun, and there is a constant presence there.

We buy shares of quality companies to hold until we want or need the money. The “rule of five” tells us that, of every five companies we select, we can expect four to do as well or better than expected, but one is likely to disappoint us. And, occasionally, the herd will bid up the price of one or another of our companies to a point where we can no longer expect as healthy a return going forward as we did because we have already enjoyed much of the appreciation. In any of those cases, we will need to replace our companies with others that will better meet our requirements.

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Asset allocation is a device used by investors and financial planners to populate a portfolio with an appropriate mix of investment vehicles selected from a smorgasbord of stocks, bonds, and occasionally other investments, each deemed to carry with it a uniquely predictable degree of risk.

Its goal is to optimize the return on the portfolio while taking into account  that investor’s tolerance for risk. And, risk aversion is analyzed using such factors as the point the client has reached in her life cycle, her current and future responsibilities, her earning capacity—as well as the nuances of his or her character and personality.

The assumption is that there is an inverse relationship between risk and return; and, the more aggressive the portfolio—one invested primarily in common stocks—the more risky it is.

Few amateur investors have the experience or know-how to apply asset allocation without the help of a professional. And, considering the view that most amateurs have of “investing,” the expense of such a professional might easily be justified. But….

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While we advocate expending the least amount of effort necessary for investment success, one urgent requirement is monitoring your portfolio to catch the poor performers before they do too much damage.

Our “rule of five,”—a convenient, statistical pigeonhole into which we can cram every failure—suggests that fully four out of five companies we select will do just fine, one even doing better than we had expected. The nice thing about that is, if we’ve selected carefully, the eighty percent of those we’ve selected will perform well enough to keep our portfolio’s performance from being too badly damaged. Read more…

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Portfolio Management consists of two simple tasks: Defense and Offense. Defense is critical and involves just what you might expect it to: protection from harm, prevention of loss.

Offense is less urgent but involves optimizing your portfolio’s performance by replacing companies whose potential return has declined, with new, high-quality companies with a better potential for return. Read more…

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A question arose recently on one of NAIC’s message boards asking whether the time was right to sell a stock that had gotten a little ahead of schedule in appreciation, and whose return had declined some. “Isn’t it time to get out and take some of the profit?” [My thanks to Ron Cooper.]

The quick and simple answer is “Never sell a stock to take a profit!”

I would hastily add that this does not preclude your replacing a stock with one of as good or better quality, and a better potential for return. But there’s an important distinction between those two concepts. Read more…

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