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One of the more confusing issues to many investors is the actual amount of money one should put into any one single security. I know it always is an issue for me, and many of our readers have requested that I display the "Team Alpha" allocation for each security held.

It started me thinking how anyone comes up with an allocation formula. The best way for me to explain what I have seen over the years is to list the "popular" ways money has been allocated into stocks.

  • Buy an equal number of shares in each stock.

This one makes everything so simple, and I have done it as well. Let's just buy 100 shares of each stock we pick no matter what the cost. Once we are done, we can see the allocation simply by looking at the dollar amount invested in each stock and its percentage against the total amount invested.

The problem is that we might have more money in one stock than we really want to, and less money in another than we should. In this scenario we might have placed too much risk money into a stock that should have less risk money allocated. All stocks have risk, so this is not a balanced approached.

  • Spend the same amount of money in each stock.

I have done this as well, and boy can it get confusing from a share perspective. Let's say we have $100,000 to invest and we have 10 stocks to buy. We allocate $10,000 per stock no matter how many shares it buys. We wind up with 1204.7 shares of one stock perhaps, and 4.642 shares of another stock. I suppose with computers figuring everything out it might not be a problem for some. For me, my eyes get confused.

The real problem is that we might own more shares than we want to in one stock because it was cheap, and not enough shares in another stock because the price was higher. To me this is not a sound balance.

  • If the stock has a lower share price we can buy more shares, and if it has a higher price we just buy fewer shares.

This one is similar to the first two ways, but at least we are looking at the stocks without a carte blanche approach. This is another allocation approach I have used as well. "Gee, XYZ is only 6 bucks and I can buy 1000 shares and still only have a 6% allocation (of that $100,000). ABC stock is $50.00/share so let's buy 125 shares and also have a 6% allocation."

Truth be told, we are actually on to something here. At the very least, we are looking at the dollar amount, the share price, the actual percentage of allocated funds, and the number of shares we can buy. I see less flaws in this allocation approach than the first two, however we are leaving out some important facts - the fundamentals, the dividend yield, and the impact on the overall portfolio.

All of this had my head swirling as to how I can actually show my approach to allocation so that it is easier for most folks to understand. Since the time of year is fast approaching for us to re-balance our "Team Alpha" portfolio anyway, I have tied it all together.

Re-Balance For Balance, With Allocation

As always, let's take a look at the "Team Alpha" portfolio as it stands right now:

Our portfolio now consists of Exxon Mobil (XOM), Johnson & Johnson (JNJ), AT&T (T), General Electric (GE), Annaly Capital (NLY), Southern Company (NYSE:SO), Procter & Gamble (NYSE:PG), Intel (NASDAQ:INTC), Realty Income (NYSE:O), Coca-Cola (NYSE:KO), Bank of America (BAC), American Capital Agency (NASDAQ:AGNC), Wal-Mart (NYSE:WMT), Cisco (CSCO), 3M Company (NYSE:MMM), Bristol-Myers Squibb (NYSE:BMY), and Healthcare Select Sector SPDR (XLV).

We have just added XLV to our portfolio as well as reducing our holdings of NLY by 2/3, and increasing our allocation towards GE (my stock pick of the year for 2013).

As reported in the latest update, our portfolio is doing nicely. It is beating the market indexes and is fairly conservative for the DGI strategy I employ, with some spice.

I think we can do better over the next 6-12 months just by re-balancing and setting some new standards for our actual allocation in each stock. What better time to do this than when we are actually re-balancing anyway. We seek balance and "alpha," so perhaps we can inch closer with this approach.

"Team Alpha" As A Real "Team" For Allocation

Since we are now in the baseball playoff period, heading to the culmination of the World Series, I thought it would be fun to explain my re-balancing and re-allocation actions using a baseball analogy.

Using the "Team Alpha" core stocks, I developed a starting lineup, my starting pitcher, and my bench. As most baseball fans know, being in the starting lineup is where we put our best "players" in the game. Based on their position in the lineup tells a baseball fan what the players strength in the line-up might be.

For example, in baseball, the leadoff hitter is perhaps the speed demon who can run quickly to steal bases, but also has the proclivity to produce a higher on base percentage for the team to move him around the bases to score more runs. If we place a stock in this position it could mean we are confident that the stock will be a consistent "producer" but not a "hit it out of the park" sort of stock.

By the same token, the players batting 3rd, 4th, and 5th, are the "heart" of the lineup. These are our power hitters who can change the game with one swing of the bat. The stocks in this position could do the same thing. They have the ability to grow huge and also have consistent dividends that keep producing at a superior level.

I believe you get the picture. Now, at the end of the year, we look at a player's salary and we might want to pay them more or less depending upon past performance of course, but more importantly, what we believe they can bring to the game in the next year.

The same can be applied to our stock holdings. We might want to invest more (raise our allocation percent) in stocks we feel can move the needle for us, or maybe reduce our investment in some stocks (lower our allocation percent), because we believe we can put the money to better use.

One might argue that we should not take dollars away from a solid dividend paying stock. I agree, but when the money is re-deployed into other dividend paying stocks, that could pay the same or even more (in some cases a tad less), we are achieving that balance we are looking for.

All of this being said, here is the "Team Alpha" lineup with actions to be taken this month:

Starting LineupAllocation% GoalCurrent Allocation %Action Needed
O 6% 5% Add
KO 3% 3% Hold
GE 8% 2% Add
JNJ 8% 6% Add
XOM 8% 8% Hold
T 8% 3% Add
PG 6% 6% Hold
WMT 6% 6% Hold
CSCO 6% 6% Hold
Starting Pitcher
MMM 4% 8% Reduce
Closer
BMY 5% 3% Add
Bench
BAC 4% 2% Add
NLY 1% 1% Hold
AGNC 2% 4% Reduce
XLV 6% 6% Hold
SO 4% 8% Reduce
Cash 15% 24% Reduce

The key actions we will take are as follows:

  • Reduce our cash position by 9%. We have decided to use some of our "dry powder" so that our money is working for us.
  • Increase our allocations significantly in GE, JNJ, T and BAC, for the next 12 months. It is my opinion that these stocks will outperform the market and are poised for a global economic recovery and stronger business climate.
  • We will reduce our allocations in MMM, AGNC, and SO for several reasons. We have too much allocated in MMM, AGNC is facing the mREIT headwind storm, and SO has underperformed somewhat. We can use the funds to prop up our "power hitters."
  • The other stocks are remaining at current allocations and will be reviewed down the road for tweaks if needed.

Considering that we will wind up with 15% in cash as we complete this re-balancing for other opportunities, I believe that by doing this sort of allocation, we can once again outperform the indexes over the next 12 months.

My Opinion

While monitoring a portfolio regularly, you might be very satisfied with your current allocation in your stock holdings. I am by no means saying that this is a one size fits all approach.

I do believe that as we move forward, we should always make certain we have the balance we seek, and the opportunity to perform at the highest level we believe we can achieve. By taking the actions noted above, in the month of October, we believe "Team Alpha" will once again produce quite nicely.

Source: Retirement Strategy: 'Team Alpha' Re-Balances For Balance, With Allocation