Fribble The 2% Solution

By SicilianDragon
February 11, 2000

I was listening to a popular financial advisor on the radio last month. I won't name names, but he is a big proponent of mutual funds. After hearing him that day, I understand why. He was explaining to a caller about the 2% rule. The rule states that you should never have more than 2% of your portfolio in any one stock.

The 2% rule is almost impossible for an individual to follow. In order to have no more than 2% of your portfolio in any one stock, you would have to own a minimum of 50 stocks. You would have to have exactly the same amount of money invested in each one. Of course, the next day, you would be in violation, so you would have to sell some shares of the stocks that went up and buy more shares of those that went down. This generates big commission costs. If you bought more than 50 different companies, you would not have to readjust as often. With 100 companies you could probably only have to adjust once a month or so depending on the volatility of the stocks you own.

That leads me to another problem: I do not have the time to do the research to find 100 companies that I think are good companies to own. I started switching my IRA money out of mutual funds into individual stocks almost a year ago and have 9 stocks so far with still about 10% left in the mutual funds. At that rate it will take me 10 years to find 100 companies.

The radio show host was explaining how this rule was a good rule to follow in order to be diversified adequately. There are only two ways to implement this rule. One only works if you start out with a lot of money. That is, to turn over the management of the portfolio to your broker and instruct him to follow the 2% rule. Eventually, you won't have a lot of money anymore, but your broker will. The other way is to use mutual funds. Again, the real winners are the professional money managers, not you. The Wise have developed many methods over the years to convince you that you need them. They had me convinced for 16 years. But not anymore.