One of my stock positions has grown substantially. Should I rebalance my portfolio?

Question

I'm a small beginner investor with less than 50k portfolio. One stock I hold has grown substantially than everything else and makes up 46% of my portfolio, but it is expected to keep growing and has only recently really been getting into the media. The PE ratio is also now high.

Most analysts are saying buy on this stock, so I'm tempted to hold. However, the stock is in the AIM market which is more risky than the main London market.

I could sell all, sell 75% to get it to a similar level as other holdings, or selling 50% which is how much it has gone up, or any suggestions on other strategy?

UPDATE:

I decided to sell 33% of the book cost (whilst the share is still at the top of break out - although it is still going up), which brought the book cost near to some of my other holdings. And I put a low stop loss on if the stock drops in value by about 20% to sell an amount which covers the rest of the book cost.

My thinking is that this gives me some profit now at a relatively bouyant point, to give me some cash funds to rebalance /(or hold some cash). At the same time it catches any last resort drastic drops. It leaves me with (with my modest beginner portfolio) a decent holding to hopefully continue to benefit.

Ultimately I am a huge fan of this stock (it is games dev market related). I'm a developer and gamer myself, and I like what they do, like the attitude of the CEO and think there is a lot of sense in consolidating this market.

UPDATE 2:

I hold a diversified portfolio and I started investing just over a year ago.

Answer 1

So, you have a portfolio of around 50k, and you're wondering whether you should change it. The question I always ask myself in this kind of situation is:

If someone gave you 50k today, how would you invest it?

If the answer is "I would put 46% into this one stock, and the remaining 54% into others" then there is your answer. If you would buy a different ratio of stocks, then that's what your portfolio should look like today.

The fact that you got to a 50k value a certain way should have no bearing on how you invest that 50k going forward.

Wanting to keep 46% invested in one stock just because you currently have 46% invested in that one stock could be a result of the Endowment effect. Be careful not to fall into that trap.

Answer 2

Before you buy a stock (or anything else to be honest) you should have an entry and an exit criteria set. These criteria should be based on a calculated metric rather than a fixed number or a subjective or emotive reason. The metric may be related to an ethical measure such as level of commitment to reducing plastic waste but should be consistently measurable even if it is on a slightly subjective scale. If you follow this methodology you will make consistently good decisions.

What does this have to do with your question?

Whether or not you should continue to hold this position should be a function of whether your exit criteria have been hit or not. If you are targeting a PE ratio relative to the industry has the higher PE ratio moved higher than the industry or market as a whole or is it moving in line with wider movements. You say that the PE ratio is high but high is relative and you need to consider what it is high compared to.

50% of analysts are worse than average. In light of that statement are you using analyst recommendations to confirm your own analysis or as an excuse not to do your own thinking? Sometimes it is good to base entry and exit criteria on some (weighted?) average of analyst's recommendations or estimates (of earnings, profits etc.) but it should not take away from the need for you to do some of your own graft. The analysts have more resources than you do but that can mean that they have too many cooks. They also aren't making their recommendations specifically to your risk and return appetites.

I would recommend setting a limit order to sell at the point where you think it would become overvalued (you will want to review this level quite often) but only consider selling a proportion of your holding if you can find another investment opportunity which has a higher entry signal according to the metrics you have decided upon.

Although AIM is "more risky" (i.e. has a higher volatility) that doesn't change the quality of the underlying company. A large move due to volatility is more likely to be downward as the returns are approximately log-normally distributed and have fat tails but you expect to see a lot more small positive movements which will outweigh the large negative moves. In all you want to ride out the negatives and allow the positive returns to build up so long as the value of the company, by your metrics, is still positive.

In summary your entry and exit criteria should be telling you what to do not random strangers. Rebalancing is a good idea if you have a better investment idea or your metrics indicate that you shouldn't be holding onto the stock at all anymore otherwise hold and stay true to your analysis.

Answer 3

In addition to the other helpful answers here, I think a practical consideration/caution is in order.

Rebalancing is a good idea in general, but it does have costs. Every time you make a transaction with a stock or fund, you incur costs - whether in the transaction itself (commission) or in taxes/etc.

That's not to say you shouldn't do it - having one stock be half of your portfolio is a recipe for danger - but it is a consideration in when you do it and how often you do it, as well as considering how much you reinvest (as if this isn't a tax-sheltered account, it may incur taxes).

Also, to avoid trying to time the market, I would suggest having a trigger that causes rebalancing. Either time (every 3 months/6 months/12 months you rebalance then), or amount (any time a stock becomes greater than 25% of your holding, you rebalance). That takes away some of the temptation to hold onto something because it's "going to keep going up".

Answer 4

Vanguard said about it from Best practices for portfolio rebalancing(Link):

• The primary goal of a rebalancing strategy is to minimize risk relative to a target asset allocation, rather than to maximize returns. Over time, asset classes produce different returns that can change the portfolio’s asset allocation. To recapture the portfolio’s original risk-and-return characteristics, the portfolio should therefore be rebalanced.
• In theory, investors select a rebalancing strategy that weighs their willingness to assume risk against expected returns net of the cost of rebalancing. Vanguard research has found that there is no optimal frequency or threshold for rebalancing, since risk-adjusted returns do not differ meaningfully from one rebalancing strategy to another.
• As a result, we conclude that for most broadly diversified stock and bond fund portfolios(assuming reasonable expectations regarding return patterns, average returns, and risk), annual or semiannual monitoring, with rebalancing at 5% thresholds, is likely to produce a reasonable balance between risk control and cost minimization for most investors. Annual rebalancing is likely to be preferred when taxes or substantial time/costs are involved.

Here are my additional opinions:

• If you are investing long-term, you shouldn't be swayed by recent performance. Take a moment before you decide. Until then, stick to your plan.
• You can change your distribution as you see fit. Then rebalance accordingly.
• Be careful though. Unbalanced portfolios get little benefits from rebalancing.
• Rebalancing is not for everyone. If you think rebalancing is holding you, maybe this is not for you. So feel free to research other strategies. Be mindful since you are taking more risk in this way.

Answer 5

Conventional wisdom is that one should rebalance one's portfolio in order to balance risk and reward, adhering to the goals of a portfolio. It's the most important decision that you can make after determining what assets you will hold.

So now you're caught between two conflicting realities - you think that it may have additional upside potential since the stock is now in the media but you are concerned about the risk of your position. You want to make the right decision but who knows what that is since the future can't be known. There's no secret formula that tells you what to do. It really comes down to fear and greed. Which emotion has the larger grip on you?

Other than rebalancing now, you have a couple of other choices:

(1) You could run a trailing stop loss on the appreciated position. This will be effective as long as there isn't a bad news/large gap down day.

(2) If the stock trades options, you can utilize a low/no cost collar that brackets current price with a profit and loss zone. It could be 5%, 10%, 15% above/ below current price. If the stock cooperates (they often don't) then there's a possibility that you could ratchet up the collar, raising the P&L range if price continues to appreciate. But at least you'd have a floor of protection that locks in the bulk of the current gain. Understand that the collar is predicated on giving up some of the upside. If you don't like that idea, don't monkey around with an option collar.

My feelings about this is that I'd rather see a position go up without me than down with me, hence the reason that I employ a lot of collars and other risk averse strategies. A lot of that has to to with my being older with more importance attached to keeping what I have than making a lot more of it. I sense that you're young and if so, your risk tolerance should be higher. How high is one of the determinations you have to make. I can't help you with that.

Answer 6

If your other stocks didn't grow at all, then this stock must have originally made up 36% of your portfolio. If the other stocks did grow, then this stock must have been more than that. You mention that selling 75% would put it at a level similar to your other stocks, which implies that your other stocks make up about 10% of your portfolio each. These numbers are quite high. With less than 50k, it's going to be difficult to diversify by buying individual stocks. It's probably a better idea to invest in mutual funds; just make sure you don't go for ones that take a large amount in fees/loads.

but it is expected to keep growing

By whom? Note that the current price of the stock is the result of the collective knowledge of everyone participating in the market. The market, as whole, does not expect the stock price to go up; if there were some higher price level that they expected it to reach, they would buy it until the stock price reached that level (leaving aside future discounting). So you are privileging the opinions of a few people who are good at getting their opinions noticed (and note that optimizing for "getting noticed" versus "being right" differ quite a bit) over the collective wisdom of the market.

Answer 7

Ultimately I am a huge fan of this stock (it is games dev market related). I'm a developer and gamer myself, and I like what they do

Note that you are gaming heavily on the stock market, by picking individual stocks, and I'd go so far as to say that it doesn't matter much what you will do next, anyways, due to this. Individual stocks can all but disappear overnight without much notice, and without you getting any warning, even if you know what they are doing (i.e., what they are producing, their mindset etc.). The fact that you know the company makes it even riskier for you, because you have the feeling that you are in control as long as you pay attention.

That said, my own policy is to pick a certain % for each item in my portfolio (which are index funds of the large markets, not stocks...), and regularly (every X years, not when an event happens) balance them out so they are roughly at their predetermined % value. This way, I sell things that have risen; I buy things that have fallen; and I keep with the overall market which I'm tracking. If you wish to, read "The Intelligent Asset Allocator", I don't know if that's still en vogue or anything special, but it helped me get a stress-free mindset about all of this.

Answer 8

Just a general rule of thumb, when an investment is successful sell a portion of it to ensure that you reap profit from that investment. When an investment reaches a target value I sell off either 10% or enough to cover the initial investment; whichever is smaller. The rest then continues to grow (relatively) risk-free. Nothing sucks more than to hang on to an investment that's growing like wild-fire then suddenly reverses. Equally sucky is selling it all too soon. This is the compromise: sell a little each time it reaches new highs.

Answer 9

Psychologically, I find it easier, in this situation, to put in a stop-loss order for a portion of the stock (or more than one, staggered). That way I won't be caught by surprise on vacation. Every once in a while, a company outperforms the market for an extended period of time. You didn't know the company was going to do this when you bought in.

Three stocks I have allowed to have an outsize percentage of my portfolio are LUV, AAPL, and at the moment NVDA. I'll wait for several months of under-or-market performance before trimming the position.

Answer 10

The best quote regarding your situation, i.e. to diversify or not to diversify is:

"You do not get rich by diversifying, you stay rich by diversifying". The author's name unfortunately escapes me.

So the question is back to you if you reached your goal with this stock.

And Peter Lynch would praise you for investing in the field you know, instead of betting on small cap biotechs given you are coming from the gaming industry.