Building a Portfolio for Long-Term Success

Determining how much money to allocate to each investment can be tricky. Here are some simple tips to design a strategy to maximize confidence in one's holdings and allocation strategy.

Apr 9, 2014 at 6:15PM

New investors often ask the question, "How much money should I allocate to each investment I make?" 

This is a great question! And the honest, realistic, and Foolish answer? It depends on the investor.

Mold your strategy around you 
In a working adult's IRA, the dollar amount allotted to each investment will likely be considerably higher than what I can allocate to investments in my individual portfolio as a student in college.

Even so, the meager $80 I invested in Netflix (NASDAQ:NFLX) in 2006 is worth well over $1,000 today. Netflix ballooned from 5 million subscribers in 2006 to more than 44 million subscribers in 2013 and counting, expanding sales at an average rate of 23.5% annually between 2006 and 2013.

Netflix shareholders have benefited greatly from the visionary leadership of co-founder and CEO Reed Hastings, who from the very beginning recognized the need for Netflix to adapt to new mediums.

In his 2005 letter to shareholders, Hastings wrote, "The winners in downloading will be the companies that provide the best content and the best consumer experience, and that's what we do best." Less than a decade later, not only is Netflix an undisputed leader in streaming movies and TV programs, but the company is also producing its own original content. What a difference visionary leadership, an innovative product, and 10 years can make.

As you search for your own multibagger investments, keep in mind these (paraphrased) words of popular Motley Fool member Tom Engle (TMF1000): "If a company is the next big thing, a little position is all I need. If it isn't the next big thing, a little position is all a want."

Peter Lynch, investor extraordinaire and former manager of Fidelity's Magellan Fund, puts it this way: "All you need for a lifetime of successful investing is a few big winners, and the pluses from those will overwhelm the minuses from the stocks that don't work out."

In other words, individual investors don't have to bet big and commit all of their investing money to one or two investments. Building a diversified portfolio of quality businesses with great long-term prospects is the best way to achieve market-beating results over the long haul.

With this in mind, it is helpful to focus on percentage allocation, rather than the dollar amount invested in each stock. A rule of thumb used by some investors is to invest enough funds in each position so that commissions make up no more than 2% of your total investment. In other words: If your brokerage charges you $7 to buy shares of a stock, the minimum amount you would want to invest with each trade would be $350 (of which 2% is $7). This helps ensure that commissions do not eat up a significant portion of your investing dollars.  

Opportunities with diversification 
When a stock jumps in the short term, it can be easy to convince ourselves that we should have purchased more shares of that stock. But would you have felt comfortable holding a larger position if the stock had dropped 20%? Consider this when determining how much you want to invest in any given business.

We should be confident in all of our investments, but the benefit of diversification is that we can begin to look past the short-term volatility that will inevitably come about when investing in individual stocks. So consider expanding your portfolio beyond just a handful of stocks. We want to invest enough so that we benefit if a business succeeds over the long haul, but we also don't want to invest so much in one position that we hyper-analyze every little market movement and panic if the stock doesn't perform as anticipated.

Some investors opt to "buy in thirds," easing into individual stocks by purchasing their total position in increments of one-third over time. A potential downside to this strategy is the fact that the long-term trend for the market is to go up, in which case delaying investments into thirds over time can sometimes be counterproductive (or less rewarding than opening a full position from the get-go). On the other hand, going all-in with a full position right away can be difficult to stomach if the market or the individual stock should take a turn for the worse.

Foolish bottom line
It is important to manage your portfolio in such a way that leads you to focus more on the underlying businesses behind your stocks -- and the long-term prospects of those businesses -- rather than getting caught up in short-term market movements. Allocate your money in such a way that maximizes your confidence and comfort levels and minimizes uneasiness with your investments, allowing you to keep the bigger picture in mind. Volatility is all but guaranteed with individual stocks, but focusing on the business behind each stock can help investors avoid emotionally driven decisions based on short-term price swings.

The Pencils IRA Project -- a personal real-money portfolio -- is my attempt to build a portfolio of quality businesses with significant potential to generate market-beating results over the long term. The dollar amounts allocated to the individual positions in this Roth IRA portfolio are nothing huge, but the portfolio will prove to be lucrative over the long haul if only a few of the holdings prove to be big winners. With investing, starting small is better than not starting at all.

The greatest thing Warren Buffett ever said
Warren Buffett has made billions through his investing and he wants you to be able to invest like him. Through the years, Buffett has offered up investing tips to shareholders of Berkshire Hathaway. Now you can tap into the best of Warren Buffett's wisdom in a new special report from The Motley Fool. Click here now for a free copy of this invaluable report.

David Kretzmann owns shares of Netflix. You can follow David on his Foolish discussion board, Pencils Palace, on CAPS, or on Twitter @David_Kretzmann. Learn more about David's Pencils IRA Project at The Motley Fool recommends and owns shares of Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

Click here to learn about this incredible technology before Buffett stops being scared and starts buying!

David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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