Portfolio Maintenance

by Robert Sheard
(TMF Sheard)

LEXINGTON, KY. (August 26, 1998) -- In yesterday's column I talked about risk protection through diversity, often misunderstood to mean "buy everything to cover yourself." Today I'd like to talk about portfolio maintenance techniques with an eye turned towards safety, as well.

When I first began tinkering with mechanical screening techniques, I worked from the idea that one should let the winners run totally unchecked. When a stock fell out of one's portfolio, I believed one should use only those proceeds to buy its replacement, leaving the remaining stocks alone.

But time and a few disasters later, I modified that belief. When a stock grows to dominate a portfolio, it's an invitation to disaster. And we've seen a number of stocks suffer that kind of disastrous fall in recent years, despite what the fundamentals at the time may have seemed: Micron Technology <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MU)") else Response.Write("(NYSE: MU)") end if %> shooting from the teens up to the mid 90s and then right back down to the 30s, Iomega <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: IOM)") else Response.Write("(NYSE: IOM)") end if %> giving up huge profits after setting the markets on fire.

In the absence of any credible way to pick tops and bottoms in such stocks, it makes sense to me to rebalance the weightings of one's positions periodically so that a Micron or an Iomega doesn't become 20% or 30% of one's total portfolio value. Now, I'm not arguing that every good stock should be cut off at the knees as soon as it hits a certain percentage gain, but I do feel that a stock that's been in one's portfolio for a year, let's say, can stand to be reevaluated, not just to determine whether it should still be held, but also if the weight it carries in the overall portfolio should be adjusted.

With my mechanical screens, of course, this can be done each year, if necessary, as one updates the holdings. I don't believe one has to be rigid about the rebalancing, however. If the adjustments mean a bunch of tiny trades that simply rack up commissions for your broker, don't bother. But if a stock is considerably heavier than the rest of your holdings, consider spreading some of that profit around to the other positions.

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[Robert Sheard is the author of the The Unemotional Investor (Simon & Schuster, 1998) available now at Amazon.com and your local bookseller.]