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3 Principles for Portfolio Allocation

Matt Cochrane offers the guidelines he uses to build his personal portfolio.

March 22, 2021

Portfolio allocation is probably just as important to investors’ returns as actual stock picking, yet few give it the same amount of attention (including myself). Because I didn’t give this concept much thought, my portfolio was haphazardly constructed for many years. Sometimes I would enter a position all at once. Other times I would slowly ease into a position by dollar-cost averaging.

Over time, primarily through learning by mistake and discovering my own comfort levels and investing style, I began to formulate guidelines for how I think about putting together my portfolio, most of which revolve around these three principles:

  1. Move slowly. I’m never in a rush to build a position anymore, so I just buy a little at a time. That first bite can be quick, though, before I’m done thoroughly researching a company. So I start small, but if the thesis holds and my confidence grows as I learn, I’ll add over time. If not, I’ll sell. While I’m a long-term, buy-and-hold investor, I can quickly sell small positions that I buy before completing my research. I think of this as time diversification.

  2. Make stocks earn their position. To become a significant position in my portfolio (say anything over 5%), the stock must do a lot of the heavy lifting. This is especially true for my largest positions. I’ll keep buying to a point, but eventually, positions need to earn their keep.

  3. My largest positions, especially by market cost, are those that I believe won’t lose a lot of money, rather than ones I think could gain the most. For example, my Paycom Software (NYSE:PAYC) and Shopify (NYSE:SHOP) have grown so much that they would’ve been top positions if I had never trimmed them. But with those valuations, I know drawdowns are likely, and so have cut a little on the way up. I give myself permission to trim and add to positions based on valuation, though I never sell out of a position entirely due solely to valuation.

These principles naturally steer my portfolio so that my most significant positions are the ones I’ve held the longest and are those with which I am most familiar.

I believe it is challenging to run a concentrated portfolio and be a long-term, buy-and-hold investor. Since I sincerely believe the best compounding comes from years of holding, I allow myself to hold 30-40 positions at a time, though I will eliminate positions at that point. Starting small and allowing my portfolio to balloon over 30 positions permits me to buy companies I would not otherwise have. For instance, I doubt I would have ever bought Shopify, a 13-bagger for me, if I had some arbitrary rule telling me it would have to start as a 5% position.

This is what works best for me. Some investors I know, though, run a much more concentrated portfolio and have seen gangbuster returns. Others have portfolios with literally hundreds of companies, and they too have succeeded wildly. When it comes to portfolio allocation, there is no one-size-fits-all. Find the style that best suits you, and invest accordingly.

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