This article is a continuation of a series of articles on portfolio management, including the topics of : how to allocate capital, how to size positions, how to incorporate sell disciplines, and managing correlation in your portfolio.
In this article, I discuss the topic of creating buying programs for your investment ideas. If you would prefer to listen to my discussion of this topic, I talk about buying programs in episode 32 of my podcast.
Before I give you my take on buying programs, I will quote from the master Warren Buffett, who in his Buffett partnership investor letter in 1957 said :
“Obviously during any acquisition period, our primary interest is to have the stock do nothing or decline rather than advance. Therefore, at any given time, a fair proportion of our portfolio may be in the sterile stage.” Sterile stage referring to stocks that have not shown gains yet."
In his 1958 Buffett Partnership letter, he adds”
“[In the 1957 letter] I pointed out that it was in our interest to have this stock decline or remain relatively steady, so that we could acquire an even larger position and that for this reason such a security would probably hold back our comparative performance in a bull market.”
In the same letter, in discussing a particular position, he said:
“Over a period of a year or so, we were successful in obtaining about 12% of the bank… ” and “It is obvious that we could still be sitting with a $50 stock patiently buying in dribs and drabs and I would be quite happy with such a program although our performance relative to the market last year would have looked poor.”
Take a position over the course of a year or more to have the chance of a lower price
Buffett is giving us clues as to how he would take a position. He mentions the period of a year or so to give himself to take a large position. At least in his partnership days, Buffett wasn’t loading up quickly on positions. He would take one over a period of at least a year.
Why a year? One thing that was going on was Buffett was buying a decent amount of illiquid stocks. He mentions stocks that trade by appointment only, stocks that trade only every other month or so. That is one significant reason for his having to take a year or more to build a position.
A second point to make is that by extending your buying over at least a year, you have the chance to buy during periods of falling prices. If you load up at the wrong time of year, for example in January – March, you may miss the opportunity to buy cheaper during seasonal market softness such as October / November time-frame.
Take advantage of opportunity cost by spreading your buying out over a year
You can take advantage of opportunity cost over time by spreading out your buying over a year or more. Not just in market fluctuations, but in having many choices of which securities to buy. By keeping capital handy for a buying program over a year or more, you have dry powder and can allocate based on the relatively cheapness of different securities.
For this reason, my recommendation for retail investors and especially those just starting out, is to buy only once or twice a month and take a full twelve months to reach a full position in any one stock.
New investors should not "load up" on a favorite idea
You will naturally feel an internal pressure to load up more on something you are buying if a stock is falling in price. Having a discipline of not buying more than twice a month, and taking twelve months to build a full position will give you parameters that should keep you from buying too much too soon.
No one can predict the direction of the stock market or an individual name. Just because a stock has fallen in price does not always mean that it will go back up to your original buy price. What if the stock continues to fall long after you have a full position from buying to early and too often?
Size your positions based on calculations specific to the size of your pool of capital
The actual size of the position that you take will be based on a number of factors and you can read an article I wrote on the topic of position sizing as a reference. Follow the advice in that article and you will have a good idea of how to size your positions based on your capital pool.
The thrust of this article is that you should take a position over the course of a year, not less. This allows you to take advantage of opportunity cost, will keep you from loading up, and will require a specific position-size calculation. Having specific buying plans will keep you from making major beginner level mistakes.