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Managing Your Portfolio - Weightings

There has been a lot of discussion on how you should weight your positions. In my opinion, this is one of the most important aspects of portfolio management.

Part of the weighting issue also includes how many positions you should hold.

One of the most valuable lessons I learned when I was swing trading, was position sizing. Swing trading is an exercise in taking many small to medium profits, over and over again. It was also an exercise in managing the losses as well.

I recall a time when I had 5 or 6 successful trades in a row, felt confident, the market was rising, and I found a sure winner. I over weighted the position and I lost money on the trade. The worst part was, that trade cost me all of the profits I earned on the previous 5 or 6 trades.

I had an 80% success ratio on picking winners, but it was wiped out due to one bad trade. From that point on, every position was the same dollar amount.

As a dividend growth investor, this concept has saved me more than once. Most of us are knowledgeable about selecting positions. We know what to look for. We are confident our selections will follow through and provide us the returns we expect over the long term. Most of us are experienced enough to know that doesn't work in reality. Therefore, I prefer to insure myself against a case of "the stupids."

BP was my "stupid." EXC was another.

I owned BP when the rig in the Gulf exploded. At the time, I didn't fully understand the impact it would have. I knew there would be ramifications. I knew the share price would suffer. What I didn't know was how much damage that spill was going to cause.

In retrospect, I should have sold that day, but I didn't. I'm sure some of you have experienced that "frozen deer in the headlights" syndrome at some point in your investing career.

I thought that BP was financially sound enough to weather the storm, and they were. I thought as long as they continued to pay the dividend, I would reinvest the dividend at lower prices, thus building my position for the eventual turnaround.

I was further encouraged by the fact that the BP dividends were one of the largest contributors to the UK pensioners. Surely BP wouldn't screw them!

BP announced the dividend was safe and in fact, declared the dividend. So, I kept the position on auto pilot. Just days before the dividend was supposed to be paid, the CEO of BP was called to the principals office (Mr. Obama). They pressured BP into discontinuing the dividend.

At that point my position was down 47%. I didn't know how long it would take to recoup that loss. I had no idea when the dividend would be reinstated again, if at all. I decided to lock my losses in. I sold the position.

A lot of people would look at that 47% loss and determine they couldn't take it. A lot of people would think they were forced to hold until they could earn their money back. ... That's crazy thinking! And here's why.

It has to do with position sizing. At the time, due to the number of positions I owned, BP only represented 4% of my total portfolio value. I lost 47% of that. The loss to the portfolio was only around 2%. Think about it! ... A 2% loss is nothing in the grand scheme of things. It's the total portfolio value we must think about. It was much easier to take that loss based on that. The only real damage was my ego. I can get over that in time. However, it took no time at all to make up that 2% portfolio loss.

The more over weighted your position is, or the higher the percentage of your portfolio that position represents, the higher your losses are going to be, and the longer it will take you to make up for them.

I think I can promise you, at some point risk is going to meet adversity. Count on it!

Rather than focusing on the gains, I focus on minimizing the losses. If I do that successfully, the gains are going to be there.

EXC was another "stupid" that I experienced. When I purchased it, EXC had a nice yield and they had a nice dividend growth string going. There were several double digit dividend growth years. Then came the CEG merger. EXC had to freeze the dividend to make the merger work.

I was okay with that at the time. The yield was north of 5% and I thought I'd simply reinvest the dividends and wait for EXC to assimilate the CEG merger and then get back to business. Then came a series of set backs.

Reaping the benefits of the merger was taking longer than expected. The State of Illinois was being difficult with rate increase requests. Power prices were dropping and hedges were coming off the books and EXC had to renew at lower prices, thus lowering revenue. And then the biggie. After assuring us that the dividend was safe, the CEO stated they may have to lower it in about 6 months.

None of this was considered by me in advance. I didn't know this was how it was going to play out.

As soon as the CEO warned about the dividend, I was out immediately! By this time, my capital gains had disappeared and I was now down 19.34% on the position. I took the loss and moved on.

Instead of focusing on the 19.34% loss, EXC at the time was actually under weighted because I wasn't going to add to the position while the dividend was frozen and they were still trying to work with the CEG merger. The loss to my total portfolio value was just 0.14%. Wheee! Much ado about nothing.

So in closing, my message is this. When you have a sizable loss, don't focus on that one company, measure the loss against your total portfolio value. If you own enough positions, and you have them sized properly, you'll see that your big mistake is actually a small one. Correct it before it does more damage, not just to your portfolio, but to your psyche as well.