Let’s say Joe Investor is dissatisfied with his portfolio performance. In haste, he sells all his stocks that are losing money and buys more of his winners. He feels good about his decision until a few months later when he’s in a similar situation. He does some more research. Joe has a portfolio of over-priced stocks and has some missed opportunities with the stocks he sold.

Chasing the high flyers is synonymous with driving down the road in a forward direction while using your rear-view mirror. Joe Investor was right to reassess his holdings. You should always monitor stocks you hold to see if there have been any changes in the fundamentals—cash flow, return on assets, valuation, history of profit retention for funding future growth, the soundness of capital management for the maximization of shareholder earnings and returns—to name a few.

You sell the losers if and only if they have no hope of recovery. Losers are often the most promising future leaders. For example, oil stocks lost 55% from Feb. 19, 2020, through March 23, 2020, while the market lost almost 34%. Since then, they have recovered 54% while the S&P 500 has gained 41%. You need to understand why the market price moves and be able to determine if a move is potentially short-term. If fundamentals remain intact, consider holding the losers.

There are two major components to portfolio management: allocation and selection. Allocation refers to the weights of each industry sector included within the portfolio. Selection refers to the individual stocks held within each of these sectors. I focus on high-quality companies, meaning I look for companies with no debt or easily manageable debt, and predictable earnings. This screen for high quality leaves us with a list of investible companies that generally excludes approximately half of the S&P 500 companies. After these high-quality companies are identified, I look for companies with attractive prices relative to their historic price ratios and the ratios of their industry peers. I also look for companies with above-average profitability and earnings growth. This produces a list of companies I consider attractive for investment. In the process of allocation, I consider economic and financial market conditions to guide my decision for industry sector weighting within the portfolio. Since I consider risk management a key concern, I generally will give up some return to protect assets during a downturn, as many of the events that trigger them are difficult to forecast.

Consider the latest iteration of downturns, which was unmentioned until January 2020 and didn’t impact domestic financial markets until February. If stock analysts had been able to foresee the issue, we all could have avoided the 33% downturn from February 19 until March 23, then reinvested to enjoy the rebound. However, not everything can be forecasted. Therefore, I prefer to include positions in stable sectors like Consumer Staples, Healthcare, and Utilities to soften portfolio losses. These sectors are not known for their earnings growth, but they are reliable.

In working to eliminate the risk of specific loss, I arguably mute the potential for overall gains. In managing this risk, I include portfolio exposure to all 11 sectors of the financial markets and several stocks within these sectors using the criteria laid out above. I have missed opportunities at times and have included companies with promise that never blossoms. However, the process was created and is adjusted with significant thought and is based on historically proven fundamentals.

I’m not denying that momentum in a sector or select stocks is great, but we know it can end abruptly. Historical performance is important, but your portfolio should mainly focus on the potential for future success. You will always have a few losers, but they may be tomorrow’s big winners.

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William G. Lako, Jr., CFP®, is an Executive in Residence at Kennesaw State University’s Coles College of Business and a principal at Henssler Financial and a co-host on Atlanta’s longest running, most respected financial talk radio show “Money Talks” airing Saturdays at 10 a.m. on AM 920 The Answer. Mr. Lako is a CERTIFIED FINANCIAL PLANNER™ professional.


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