Don’t Bet The Ranch And Have To Buy A Cowboy Hat

Cowboy Hat

We often hear stories about people who “bet it all” on one investment, or business, and became fabulously wealthy.  What an appealing story that is.  It gets me all fired up just thinking about it.

But before we all rush out and bet the ranch on that big investment idea we just heard about, it’s good to think this over for a bit.

Because for every investor that bet the ranch and won, there a many that bet the ranch and lost the ranch – and sadly, are now working as poor cowboys on the ranch they used to own.  We have to remember that the news reports the winners far more often than the losers.  History is written by the winners.

None of us are immune to the temptation.  I have a natural gas pipeline investment in my port folio that went up 400% and pays over a 20% dividend.  Why wouldn’t I just make the big leap and put everything into that, sit back, and watch my fortunes grow.

Because the world can change in ways we can’t imagine, that’s why.  And it can change rather quickly.  What if I was to wake up some morning and read that there have been some accounting irregularities discovered at the company and the stock had just plunged 400%?  I think I’d be in the market for a cowboy hat that day, don’t you.  Because I would have bet the ranch – and lost it.

The rumor of accounting irregularity wouldn’t even have to be true for it to wipe me out.  Some competitor might have made it up.  But it doesn’t matter, really.  The market would still punish me with a loss.

I own a position in a gold and silver mining company, an excellent company, I believe, that just experienced a rumor of accounting irregularities.  I’m down 19% because of that rumor.  But I’m not worried (well, maybe a little bit) and it didn’t wipe me out.

Why is that?

Because I didn’t bet the whole ranch on the investment.  So I’m not wiped out – not even close.  I can live to play another day.  In this case, I can, and will, ride it out, because I think the company is so strong it will come back and the accounting issue will be cleared up.

So how did I position myself to be that durable?  Because I only invest a certain amount of my portfolio in any one stock.  I position myself so if any one of my investments goes totally south, I don’t lose more that 1% of my portfolio.

This whole concept is called position sizing, and I do it in a very simple way.

Here it is.  I never invest more than 4% of my portfolio in any stock.  And if that stock goes down more than 25%, in other words, it dropped by 1% of my portfolio, I sell it.

Here’s how that looks by the numbers.  Say I have a $10,000 portfolio.  I will not invest more than $400 (4%) in any one stock.  If a stock goes down by 25%, by a fourth, from $400 to $300, thin I sell it.  That way I never lose more than 1% ($100) of my portfolio on any one stock.

To be successful investors, we want to grow our portfolios steadily and live to play another day.  We don’t want to try to make it all in one giant leap.  Or as Warren Buffett says, “I don’t look to jump over 7 foot bars.  I look around for one foot bars that I can step over.”

So keep the size of your investment in any one stock to no more than 4%.  Your investment life may not be as thrilling, but I bet you sleep better at night.

And you won’t wake up in the morning to find out you’re going to have to buy a cowboy hat.

To your health and prosperity – John

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