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Hi everyone,

In the Transocean write up (, I said at the end that I'd be opening a 2% position ($340) on the way to a 4% position. (For the record, TMF bought for my account on Tuesday 6 shares at $63.94 -- wouldn't you know it, right near the high for the day.) And I called it not a full-conviction 6%.

So why am I choosing those numbers and how big would I let a position grow if it's wildly successful?

Well, the target position sizes of 2%, 4%, and 6% are based on invested capital as a fraction of total available ($17,000). For the 4% and 6% positions, I plan on buying in 2 or 3 stages to minimize risk of going all in just before a big drop in price. The commission cost (which we are being charged) is very low, thanks to the broker (I believe we're using Interactive Brokers). That purchase cost me $1 in commissions.

So why those size allocations?

In the Fool's analyst development program which I completed late last summer, one of the (many!) readings we went through was this article from Zeke Ashton of Centaur Capital Partners (I don't know if he's still there). In it, he discusses position sizing as a function of confidence in the idea. Most confident, largest position size; less confident, smaller; and so on down to speculative, smallest.

The reasoning is that you want to have enough money in the ones you expect to be most right about to give you a good push to the portfolio's results, while if you are completely wrong on the lower confidence ones, the blow up doesn't hurt as much.

Now that makes a lot of sense to me, so I decided to apply it to this portfolio. Unfortunately (or fortunately, depending on your point of view), I don't have a large pot of money in order to finely tune the position sizes into the four categories (or more, if you subdivide them) that he outlined for the long side of the port. If I make the divisions too small, then a single share could push the size into a higher or lower category, depending. So, I settled for three target sizes, ranked by how confident I am or how risky I view the stock.

Taking this back to Transocean, I'm quite convinced that the market is pricing in too much pessimism about the company's prospects going forward. The company is the largest rig operator in the world, has the vast majority working outside the Gulf, and has three newbuilds coming on line over the next six months at respectable dayrates. The liability for damages or lawsuits is unknown and will almost certainly drag out in court for several years while Transocean and BP fight over those indemnify clauses in the contract. (I agree with management that overturning those clauses would set a horrible precedent and you would see all kinds of ripple effects in every single business-to-business transaction around.) But the risk is there.

Because of that, and because the company has a relatively high level of debt compared to its peers, I decided that, instead of a 6% position, I'd go for a 4% position. If I'm right, it will still be large enough to help the portfolio. If I'm wrong, it won't hurt as much as it would if I put too much in.

Anyway, at the end of each buy article, I'll mention the target position size and that I'm buying the first or second (or third) increment to reach that target.

How do you look at position sizes in your own portfolios?

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No. of Recommendations: 11
I thought I would add my amateurish 2 cents.

But first some background:
In early 2007, I had mostly stayed out of the market as I felt that the market was over-valued. When cab drivers were selling their cabs in China to trade in the stock market, you just know that something's ain't right anymore. In any case, I like to think that I did well there, staying out. When the first wave of correction swept in around Aug/Sept 2007, I thought I was ready and picked up what I perceived to be bargains in VLCM, BWLD and FMD (tragically). Looking back, the mistake was that it was simply investing too much too fast - perhaps the long wait had made me too eager.

Enter April 2008, with the recession now in full swing and prices dropping much lower than what I had anticipated - my portfolio was in shambles and I was not quite sure what to do. My cash position was limited, therefore I was selective and could only afford to sit and watch.

I chanced upon an article about "wiping the slate clean" i.e. selling everything and starting over with a clean sheet of paper (portfolio). It was a breath of fresh air and also opened my eyes to the disproportionately high amounts of % I had allocated to companies which I did not have much (or less) confidence in (VLCM/SNHY/IIVI/FMD/BWLD) and in turn lower amounts in companies which had more control over it's future (CMG/MIDD/NFLX/DLB).

In essence, what happened was that I had chased price THEN the company when it should have been the other way around. Allocation was unintended result

My BIG take-away from this is that one should first decide what company which they have the most confidence in and THEN decide what price/allocation to purchase it. Not the other way around.

With that now clear, I re-allocated my portfolio (taking some losses also), concentrating my cash NFLX/CMG/MIDD/DLB. And it has been the most satisfying decision I have made.

The performance since then has been (as of today):
NFLX - up 630%
CMG - up 300%
DLB - up 106%
Note: I sold MIDD for a profit of 21%

So, my learnings so far (they may sound TMF1000-istic):
1) It's ok to start small % allocation
- I have also opened a small position in ATVI in May 2009 and to date, the price basically has not changed. Lots of gashing of teeth in the boards right now but I find myself calm as I had not committed a high amount. Had I committed a higher amount, I reckon that I could be showing concern on the amount of cash tied up in this investment. But instead, the small amount did not bother me and I have spent more time reading about the performance of the company.
- I also had the unusual good fortune to open a position in PCLN on May 2010. The stock subsequently plunged 10% further down before going to gain 93% (as of today). Small allocation or not, a 93% return in a little less than 5 months has been incredibly satisfying. In the past, I think I would not had the guts to plunge in (with the volcano in Europe and Greek debt) as I would have had to commit sizable % of my cash position. My conservative nature would have caused me to miss out.
- Smaller positions also allowed me to diversify as I could not afford the amount of time which Peter Lynch or Philip Fisher spent in researching.

2) Spreading allocations over longer periods of time
- With the flashing prices every second, it's easy for one to feel that a long period of time has passed when it has only been months.
- To that, I have added the date of purchase on my Morningstar portfolio tracker to remind me exactly how many months or weeks have passed. More than once, it probably had saved me from thinking nothing is happening and doing something rash.
- Investing action (buying or selling) should be kept as boring as possible.

3) Know thyself
- I find myself reliable enough to avoid over-optimistic stock prices (as early 2007 as shown) due to my conservative nature. I am comforted by the knowledge that Peter Lynch has missed out on many multi-baggers and still was able to produce 30% annualized performance.
- On the other side, I needed a more structured way to manage my buying especially during corrections and I found that small allocations is working for me to keep my logical side of my mind un-fluttered. A lot of credit goes to TMF1000 for sharing.

4) Timing may not matter in the end
- As I look at my best performers, it's actually interesting that I had opened those positions in NFLX in Jan 2007, DLB in Sept 2007, CMG in Feb 2007. Yes, right before the Great Recession started.
- This actually reinforces my thinking that it's how much you allocate and the quality of the company that matters over the long term. And whether the company is "fortunate because it is able" (paraphrasing).

5) Concentrating more on portfolio strategy
- Smaller positions also released my logical side of mind to concentrate on portfolio strategy
- The revenue/profit data-points from 2009 has been valuable for me to seek companies which demonstrated growth even in the Great Recession. I have opened small positions in AAPL, AMZN, BRLI, ISRG and PCLN -- so far, this has surprisingly quite positive in a short time.

Of course, this is not the only way to invest but I thought I would share find that this approach seems to works for me best. Still learning to find confidence to add on rising price (but better value points) and what to do with NFLX.

All the best and thanks for reading.
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Hi HLChin,

Fantastic. I think you've found a good strategy that works for you and thanks for sharing it.

The slowing down part is the hardest, I know. You get so wrapped up in the price movement and you know it's a good opportunity and you don't want it to get away from you and, and, ... and you end up buying way too soon.

For me, that happened with Nokia a few years ago, I think spring of 2004. It reported a first-ever drop in cell phone market share and the stock was punished brutally, down something like 33% in two days. I bought fairly soon after that news came out, but the stock kept dropping all through the summer, falling another 20% or 30% before bottoming out. I rode it all the way down (without buying more) and then back up for an eventual gain. But way too soon on that. Would have done much better if I had waited longer -- not to find the bottom, but to let the bad news really seep into the price -- and/or had bought in stages. Tom (TMF1000) has taught a lot of people around here... :-)

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My BIG take-away from this is that one should first decide what company which they have the most confidence in and THEN decide what price/allocation to purchase it. Not the other way around.

Ever notice how much Warren Buffet's quotes make their way into our conversations?

WB: "I'd rather own a great company at a fair price than a fair company at a great price."
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Great discussion!

and more food for thought. I am still struggling with 'proper' allocation and the question when to sell or hold onto a winner (or loser that may yet become a winner).

Peter Lynch has missed out on many multi-baggers and still was able to produce 30% annualized performance

To keep things in perspective, let us not overlook that Mr. Lynch's record of outperforming the market averages while managing the FidelityMagellan fund was achieved during one of the longest periods of advancing prices in stock market history. His record of a 29%-30% annual return remained largely untested since he resigned in March of 1990 at the ripe old age of 46 “for personal reasons” and before an extended period of market decline. A few years ago I read a scathing critique of his private investments after he resigned from the Magellan fund. Most of his new acquisition were penny stocks, almost all of them losers and not a single winner among the lot. This is not to say that I did not enjoy his books or found his advice useless.

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Hi im,

Thanks for sharing.

I agree about Peter Lynch's performance were during good times -- I guess I am (in fact) cherry-picking specifics but it works for me to have this comforting thought. I have not read about his life after Magellan so I can't comment on that. I was under the impression that he left Magellan to spend more time with his family.

On when to sell and hold -- I think that the tough part about the typical investor is that we all have limited funds and therefore are likely to not to make the most optimized decisions along the way. Time horizon and imperfect foresight is also a factor.

e.g. recently, I had sold NVDA before it's 40% run-up and have invested in BRLI instead. In the short term, comparing the performance would conclude that I made the wrong choice and perhaps should have been more patient. However, in the long term, I continue to believe that BRLI has the bigger growth possibilities and NVDA faces a challenging transition -- I may well be dead wrong.

Along the way, I had sold positions in MRH (sold at $12, now $17), PRAA (sold at $45, now $65), MIDD (sold at ~$50+, now $76) -- if I had the wide financial bandwidth, I think would have held on to them. Smaller allocations may help also.

In any case, I accept that I would not be able to optimize performance without hindsight. I do not know what is the best way and less time consuming way to measure my re-allocation performance but so long as I am profitable in my investments, that works for me.
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Hello All:

Interesting discussion. I completely agree with the assertion that position sizing based on confidence is of the utmost importance. While, I don't have much more analysis to provide, I think I can communicate the learning process that brought me where I am today; 35 stocks with none under a 1% allocation, and none over 15%.

When I first started investing, I threw equal amounts of money at any idea that sounded good to me. This resulted in a long index-like list of stocks. As I learned basic valuation and ratios, the journey took a turn into creating a GARP, ratio-based fundamental index, so a number of these original positions were sold.

The idea was to create a weighted average "bottom line" that looked like the ideal stock. The problem was that it got me into stocks that only looked good at a specific moment in time. Over longer periods, this approach revealed businesses with truly crappy financials, and very lumpy or cyclical earnings. I finally got religion when the "Great Recession" reared it's ugly head, and I noticed that my "fundamental indexing" was adding the very same risk to my portfolio that I hoped this approach would minimize.

With my invested capital cut in half, I upped my education, and looked backwards 10 years for businesses with a moat, and historically consistent financial results. Survival instinct kicked in, and I pulled money out of busnisses with high debt and historically cyclical results, and put all of that money into businesses that I understood very well, like AAPL at $90. I weighted them not just on valuation, growth, and other factors, but on my ability to understand and monitor their prospects. I even drew up a weighted scoring system that looked like this:

30% Value to Growth: 1-5
25% Balance Sheet: 1-5
20% Consistency: 1-5
15% Moat Value: 1-5
10% Management: 1-5

Familiarity Multiplier 1-5

Actual scoring looked like this:

AAPL $90

30% Value to Growth 4
25% Balance Sheet 5
20% Consistency 5
15% Moat Value 4
10% Management 5

Familiarity Multiplier 5

4.55 x 5 = 22.75

Because of the Familiarity Multiplier, Apple scored higher than any other idea; I had owned it since 2006, my mother had owned it since 1999, and I had been using it's products since 1990. Subsequently, I allocated 10% of my portfolio by adding to Apple at 90$ and $120.

The somewhat mechanical nature of this scoring system belies the subjective, yet informed, choices that make up the inputs. To make choices, you need to have a clear image of every facet of your ideal business. You also need to study, to determine how the business you are analyzing compares to your ideal. Before my final tally, I'd often bump up my familiarity score, after all the studying I had engaged in. In bull markets or minor sell-offs, this scoring system is less important. In bear markets, when it's harder to make rational decisions, and every stock you own seems to be a toxic asset, it really shines.

One more thought on position size. It's one thing to size a position based on the percentage deployment of investable cash, but it's another to decide what you want an ongoing position size to look like after many of your stocks have moved. One idea is to let your winners run and to cut your losers. There is some value to this idea, but doesn't take into account the various complexities of this decision. This is why I have a 1% minimum allocation. If a stock drops far enough below 1% of my invested portfolio, I have to decide if I want to buy it or sell it. If I want to keep it, I will have to buy it back up to 1%, and this requires a fairly rigorous process. Three questions have to be answered;

1) Is it at or below fair value?
2) Is my thesis still intact?
3) Are there better opportunities inside or outside my portfolio?

If the stock passes, I buy it back up to at least a minimum position. If it fails, I reallocate to a better idea, but not to cash.

As for winning positions that have moved into overvalued territory, I tend to leave them alone unless I determine that they have developed a speculative premium. In this case, I estimate how much of the stock price is speculative overvaluation, and lop that percentage off my position. So let's say CMG is fairly valued at $150, but it trades for $250. Because CMG is a good company with bright prospects, I'm okay with some premium valuation up to $200, but not with a speculative valuation above $200. Since it trades at $250, I want to cut the $50 speculative premium off the price, or 20% of my total position. These proceeds will get rotated back into the portfolio at better value points.

Other than trimming speculative valuation off a position, I don't think it's wise to put limits on how large a percentage of my portfolio a stock can grow. If one of my stocks grows to be 95% of my portfolio, I'd be thrilled.

Investing within your circle of competence and weighting your ideas based on your familiarity with a company or industry, may lead to a fair amount of industry concentration, which will occasionally lead to underperformance. It is my belief that these short-term blips will be outweighed by long-term outperformance, as long as you keep learning and building new circles of competence.

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Hi AJner,

Thanks for sharing your detailed thoughts on this question.

One thing I've learned from the approach I'm taking (2%, can up to 4%, can up to 6% -- 3 separate purchases) is that it takes more effort to get a meaningful amount of money invested than someone putting in 6% right away (my 2% = about $350; $1,000 has been a common position size for several of the other Rising Star ports, but I'm treating that amount as a full conviction 6%).

I don't know if that's good or bad yet, or even if it makes any difference in the long run. On the plus side, it forces me to look at the company again if I'm considering increasing its weighting and ask if it's still a good investment. On the other hand, a nice run up on larger positions (two others have near doubles on $1,000 investments) really boosts the portfolio's overall returns. Countering that, though, is that a bad decision won't hurt me as much as it would hurt a larger initial investment.

In the portfolio proposal I wrote back in September, before we began, I had this on the subject of position sizing. (Note, when this was written, the exact amount of money allocated to each wasn't yet set, thus the "5% to 6%" kind of ranges.)

"Position sizing in the Port will range from 2% to 6%, based on money invested. The best ideas will be from 5% to 6%. Less certain ideas will be about 3% to 4%, and least certain ideas about 2%. These are target allocations and will be reached through two or three rounds of purchasing, as noted. Total number of holdings is expected to be between 15 and 30 positions, though the precise number will fluctuate. I'm comfortable letting a handful grow to 10% to 12% of the total port, but will start trimming if it gets much above that or expectations decline."

I haven't reached 6% on anything yet, am at 4% on three, and 2% on five others, total of eight over 11 buys (not including tomorrow's purchase). I'll have to wait and see how well the upper limits described above work out, both in number of positions and size of portfolio. The expectations priced in will also play a role in selling, as I'll sell if they get ridiculously high (just as I'm buying when I think they're ridiculously low).

This set of decisions is obviously much more about portfolio management and risk management than it is about choosing what to invest in.

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Thanks for your reply. It's great to hear your insights, especially after some time to test your ideas in the rising star portfolio.

In particular, I side with your belief that one should scale into a full target allocation, as the benefit of being basically right over time outweighs the risk of being precisely wrong with one large buy. If some new information comes along that dents your thesis before reaching a full position, then you can hold off futher buys. The risk of large buys might work if you "trade into" a (hopefully) long-term position with a mental stop-loss in mind. I'm not inclined to cut my losses in any mechanical way, since I'm most likely to add to the position, unless a material event has shaken my resolve.

I'd like to hear more about how you decided on a max position size of a position that has appreciated to 10-12% of the portfolio. My question is: Isn't overvaluation the main risk with this position size, and not purely concentration? For example, if the stock has stayed below fair value, but has appreciated in line with significant value-creation, why not continue to let it run?

Anyway, I really appreciate your previous reply, and eagerly look forward to following this board.

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I'd like to hear more about how you decided on a max position size of a position that has appreciated to 10-12% of the portfolio. My question is: Isn't overvaluation the main risk with this position size, and not purely concentration? For example, if the stock has stayed below fair value, but has appreciated in line with significant value-creation, why not continue to let it run?

Hi AJner,

You ask a very good question. After all, we at TMF espouse that we should let our winners run. David G, of all of us, is the best at doing this, with some fantastic results (look at his own investment in AOL from way back when or Netflix more recently).

I'm still exploring this role of investing other people's money and doing it with the philosophy / strategy of messed-up expectations (MUE). And it's both considerations that lead me to limit the holding size to 10% to 12% of the portfolio. Let's see how well I can articulate these thoughts (which, of course, helps clarify my thinking).

In my own portfolio, I had one position that I let grow to become 30% of the portfolio's value. It was to the point that 90% of the daily change in portfolio value was due to that one stock. Pretty drastic. So, I trimmed it back to about 10% and am now letting it grow again (actually, shrink, given the past couple of days, haha). But what I do in my own portfolio, with my own money, I cannot as readily justify doing with other people's money. The $17,000 I'm being given over the course of this year ($5,000 to start, $1,000 per month for a year) is not my money. I have to answer to my manager, our company's CIO, and our company's CFO on what I'm doing with their money (actually our company's, but they're the agents). It's a completely different dynamic than investing just for myself and my wife. At least, I'm finding it so.

Then there's how MUE plays out. I've used MUE in the past for a few positions in my own portfolio, and it's worked fairly well. Nokia (since sold), Transocean, 1/3 of my BP position, Veolia. But I haven't used it exclusively. That's what I'm doing here. And I'm not really sure where it's taking me, at least not completely.

I suspect what's going to happen is that as Mr. Market gets over whatever fear triggered the MUE to happen on the low side (such as Transocean last summer and fall), the priced-in expectations will rise. I'm already seeing that with Transocean. That comes about mainly from a rise in share price. Once those expectations are more reasonable based on what the company's been able to do in the past, does the share price rise slow down? Does it keep rising and overshoot to the high side so that expectations are messed up in the other direction (too much growth priced in)? I'm not sure, yet, though I suspect that the situation will be different for every company.

What do I do when that happens? Well, on the overshoot result, the answer is pretty obvious: Sell, probably in stages just as I bought. On the matching result, however?

Well, theoretically, I should still be able to get 15% annual returns (on average) as long as the company performs as modeled (ha!) and the market is reasonable (ha!), because that's the discount rate I use. So one could argue for a hold. But I'm also bound to have some misses where the low expectation was actually justified. My goal is a portfolio average annual return of at least 15%, and if I have a few failures, I have to have those that grow faster than 15% annually to compensate. So can I afford to have money sitting by, earning "only" 15%?

Further, am I giving up other, larger returns? And if I am, am I hurting the returns I could be getting on the money other people have given me to invest?

This ties into style drift, as well. I proposed a certain style for investing, and an implied consequence of that style is that it won't be long-term buy and hold. Would holding on be style drift?

Anyway, those are the thoughts I had both before writing the proposal and afterward as I've continued thinking about MUE investing with other people's money. Not sure where the answers are at the moment, but I'll get there.

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