Should you be an aggressive investor? After reading the last section, you might think that the correct answer is to not be one of those aggressive investors. This is true in some ways. However, in other ways it can be dangerous to think that you can avoid all risk because you don’t consider yourself to be one of the aggressive investors.
“Cast your bread upon the waters,
for after many days you will find it again.” (Ecclesiastes 11:1)
Solomon points out in Ecclesiastes that risk must be taken to be a fruitful investor….
The reality is that there is no holding that is without risk. Everything has risk of one kind or another. We don’t say this so that you will crawl up into a ball of fear. The point is to make you aware of the environment and assess all opportunities and the individual risk each brings.
This should also be a reminder that the Lord is in control of everything. You are responsible for what He has given you to steward, and you should continually seek Him and discern the way He would have you go. But remember that all your worries can and must be put onto His shoulders because they are beyond your control.
With that said, He still requires you to steward these assets. You must know how aggressive you are going to be. There are two things to think through here:
1) Is the portfolio you are focusing on a standalone portfolio or part of a bigger picture?
2) How aggressive will you be on position sizing?
Standalone or Part of a Bigger Whole? If the portfolio you are actively managing is the entirety of what you have, then you should certainly be less aggressive in managing it then if it is simply the most active (and aggressive) portion of an otherwise well diversified portfolio.
Let’s give an example. Let’s say that you and your brother are both managing $1,000,000. If your brother has the full $1M in a brokerage account, then he must be much more conservative then you might be if you have $300,000 of whole life cash value and $300,000 of gold and silver. A 20% swing in value to you would represent $80,000, but to your brother it would represent $200,000! You might be able to sleep well at night knowing that your portfolio has gone down by 20% if you also know you have other far more conservative positions as the bulk of your assets.
Position Sizing? This is an important question. The larger you allow any particular position to be within your portfolio, the more it can hurt or help you. It is aggressive to have large positions and can be very dangerous. It can also be the key to appreciation in difficult times.
Modern Financial Planning Theory says that you should always keep each position size small (there is disagreement on what percentage this means.) However, the flip side to this argument is that almost every investor who has made a fortune investing has done it by utilizing large concentrated positions in the areas where they were the most confident. Your still probably talking less than a third of your portfolio, but that is a huge position. One that can be devastating to the investor who is wrong. It’s not a coincidence that many of the most successful investors (who are very few in number) built massive wealth with concentrated positions while most investors lose horribly with the exact same strategy.
Let’s repeat that. Most investors who take large concentrated positions lose a lot of money! The key difference is those famous investors are good at what they do and most investors are not. You must decide how aggressive you will be on any particular allocation. This should be determined in part by how well you understand all factors affecting the outcome of the investment and how sure you are of its success. The reality is that strange things happen all the time that go opposite of what we expect. If the worst happens, how with that affect you in your aggressive stance?
For most investors, it makes sense to keep a larger number of small positions.
If your position is a single company, it should probably not be larger than 5% of your portfolio. If your position is a fund which represents an entire asset class (say a sector of the economy or a region of the world), then it can be larger. Again, think through what is possible to happen and whether or not you are comfortable with it.
This is Part 5 in a series on asset allocation and diversification. You can follow the links to read Pt 1, Pt 2, Pt 3, or Pt 4.