Avoiding High Portfolio Ownership Of Successful Investments

I have occasionally had positions that individually accounted for more than 5% of my portfolio value at the time. Those have included Realty Income Corp (NYSE:O), Kinder Morgan Management, LLC (NYSE:KMR), National Retail Properties, Inc. (NYSE:NNN) etc. I was not worried about it, because I was in the accumulation phase of my portfolio at the time of the overweighting of these investments.

Therefore, I knew that this 5% weight would be decreased by half over the next one or two years, merely because I am adding new money to my portfolio. And in the initial phases of portfolio construction, your portfolio values are relatively lower than in the later phases of portfolio build up. Therefore, new money has a much greater impact for you. If you are in a position where you have a static portfolio with no new money to invest, since you are retired and living off that dividend stream, you have a third option.

The third option you have is to simply sell a portion of your position in that company you are overweight in. I believe that this may be the best course of action for investors who are not adding money to their portfolios anymore.

In general, readers know that I am not a fan of selling, and then buying something new with the proceeds. My analysis of past transactions has shown to me that I would have been better off simply doing nothing, rather than engage in too much “trading”. In my case, the companies I have sold ended up doing much better than the ones I purchased.

If you however have a position that has a very high weight in your portfolio above 5%, you may have to consider trimming it down a little. If I had the option, I would make the sale in a tax deferred portion of your portfolio first, in order to avoid having to pay taxes on gains realized. Paying taxes reduces the amount of money you have working for you, and is in general something I try to avoid (legally of course – I am recommending about tax avoidance not tax evasion). If I have to sell in a taxable account, I would try to sell the shares with the highest cost basis first, in order to minimize the tax bite on long-term capital gains. Alternatively, I would try to sell the shares that are subject to long-term capital gains, but keep the ones that are subject to short-term capital gains. The latter are taxed like ordinary income, while the former have preferential tax treatment.

If I wanted to trim a position, I would consider trimming it slowly, rather than all at once. For example, if I had a 7% exposure to a given company in a $1 million portfolio, I would sell $10,000 worth of stock on two separate occasions. Knowing myself, I may even spread this to three or four separate sales of $5,000/each, within a 3 – 6 month period.

I would then allocate the cash in the companies that have below average weights, but are attractively valued and have good prospects.

In general, I have found that selling is difficult for multiple reasons. For example, some investors sell after a company becomes overvalued. The problem is that there is risk that the next investment may not do as well as simply staying put with the first one. The problem is further exacerbated, if the first company starts growing earnings after a lull, and the valuation turns out to be not that bad in hindsight.

Other investors may sell because they lose hope after a couple of years of flat earnings. They then project that over to infinity, and start believing that earnings will never go up. Again, things do not go up in a linear fashion. They zig, and they zag. Not everyone is a stock market millionaire because many people lose patience and sell out, the minute they perceive that there may be a problem.

It is quite likely that the company with flat earnings may have a problem. The tough million dollar question is that no one knows in advance whether those problems will resolve themselves, or whether this is the beginning of the end.

Thank you for reading!

Full Disclosure: Long O, KMI, VFC, MO, O