Veteran Motley Fool readers know why we're always on the lookout for the next Microsoft. Finding that next home run stock can make up for a lot of losers in your portfolio. Scoring just one 100-bagger -- like Dell
And we know next year's 10 best stocks are all small companies right now, as Dell and PotashCorp were when they began their incredible runs. Thus, creating a superstar small-cap portfolio to supplement your other stocks can mean the difference between a comfortable retirement and having to milk cows much longer than you expected.
But there's a right way and a wrong way to go about this -- and the wrong way can burn you. So today, let's focus on the right way to get started on the path to small-cap success. According to the experts at the Motley Fool Hidden Gems small-cap service, there are four main tenets to focus on.
1. Don't chase past performance
Switching your money into the latest hot tips usually ends badly. When your dentist, pool boy, and cabdriver all tell you they're in the same stock, you'd better start considering that you may be the last one in (which is never good).
I vividly remember the early months of 2000. The market was so red-hot that even my most value-oriented friend was despairing that he was missing the chance of his lifetime by staying out of fine companies that he knew were overvalued, like Cisco
2. Build a properly diversified portfolio
Here's where things get a bit controversial. Many investing masters suggest you have no more than a handful of stocks in your entire portfolio. If we were all masters, that would be good advice. However, unless you've been investing successfully for 15 years or more, the Gems team counsels you to have dozens of stocks in the small-cap portion of your portfolio.
One master who would have agreed with us is Shelby Davis. He bought regularly, never sold, and died at the age of 85 owning somewhere around 1,000 stocks. Did it work? Well, he turned $50,000 into about $900 million during his career. Fellow legend Peter Lynch bought thousands of stocks in his time at Fidelity Magellan. Fannie Mae
3. Always add new money
Shelby Davis didn't accumulate his riches without adding money regularly, and neither will you. The discipline of adding new money will build your nest egg faster than you ever thought possible. The constant contributions:
1. Keep you focused on investing;
2. Allow you to take advantage of the many new ideas coming your way; and
3. Let you buy more shares when prices are lower, and fewer when prices are higher.
4. Keep your small-cap exposure under control
Small caps tend to be volatile and risky; heck, that's part of their attraction and why we invest in them in the first place. With greater risk comes greater potential reward, after all. But we can't go overboard chasing that reward.
There are no hard and fast rules for percentages, but most investors would do well to keep the small guys to around 15% of their total portfolios. If, as expected, your small caps deliver strong performance over the long term, they'll really boost the returns of the overall portfolio. But if something should go wrong over the short term, it wouldn't torpedo the entire portfolio.
Foolish bottom line
1. Keep your head and stay away from hot stocks and flaming tips;
2. Build up to ownership of a dozen or more small caps;
3. Stick to a regular saving and investing schedule; and
4. Don't let small caps overweight your total portfolio,
... then you'll be well rewarded as the years roll by. This approach has worked well in Hidden Gems, which has handily beaten the market since the newsletter's inception in 2003. For the next 30 days, you can check out the entire service -- including the team's top 10 small caps for new money now -- for ... nothing. No cost at all. Here's more information.
Fool analyst Rex Moore contributes the Foolish 8 screens to Hidden Gems, and is once again available for birthday parties. Of the companies mentioned in this article, he owns shares of Microsoft. Microsoft is a Motley Fool Inside Value selection. Amazon.com and Ford Motor are Motley Fool Stock Advisor picks. Motley Fool Options has recommended a diagonal call position on Microsoft. The Fool has a disclosure policy.