Portfolio RM: Do Low Commissions Give Green Light to Hold Many Small Positions?

Discussion in 'Risk Management' started by Gravestone Doji, Mar 6, 2008.

  1. It use to be that if you had $50K or less to invest and wanted stock market exposure, you were better off buying an ETF or Mutual Fund. Why? Because the commissions to assemble a diversified portfolio of equities would eat up a significant portion of your investment capital. But with discount and direct-access brokers (like IB) charging $0.01 per share with a $1.00 minimum and $0.005 per share over 500 shares, it no longer seems like commissions should be considered as a road-block to assembling a portfolio.

    With the market trending down it's taking a lot of good stocks with it, IMHO. A lot of companies I have been wanting to get in are now starting to look very attractive and will soon be at "Good Buy" levels. But I asked myself, should I be considering building a portfolio out of the 20 - 40 stocks on my radar screen? In other words, is building a portfolio of 10 - 20 small positions (100 - 500 shares) make good sense vs. buying a few ETFs, since commissions are so cheap?

    The idea is to try and beat the market and garner a better return than just buying an index fund. (I do remember an ETF I once held in my IRA that only had 20 stocks in its holdings. I believe it was called the Janus 20 fund).

    I look at it this way. If I buy 500 shares it costs me $5 through IB. If the stocks I buy are all priced around $10 (just a hypothetical) that's $5000 in each investment. If I have 10 positions, that's $50 commissions on a $50K account. Planning on more than a 10 position portfolio on your $50K? Just reduce share size to reflect the total number of holdings you plan to manage, i.e., 20 stocks @ 250 shares per position is no different (commission-wise w/IB). The commissions are still $50, which is equal to 1/10 of one percent of the capital investment. Which leads me to ask; I don't see the cost of commissions as being prohibitive to building a portfolio, do you?
  2. Correct. Commissions need no longer be a factor in determining your decisions in regards to portfolio construction.
  3. Well I reckon that was a long explanation and description I wrote just to ask a simple question. But I sort of wanted to drive home how the "little guy" can now plan and build a portfolio if he would like to try his hand at managing money and investing in equities. With that said, here's another long-winded point I'd like to make:

    All the talk about day-trading and swing-trading is fine and there's a lot to be said for short-term opportunities in the market. But mutual-fund managers don't day-trade. And now you don't have to either. Position trading a portfolio of securities is something that can be very rewarding if you pick the right stocks and have a solid money management plan. Plus it's not as stressful as having a thousand shares of some very volatile tech-company, trying to squeeze out a quarter or fifty cents.

    Another thing low commissions opens the doors to is investment clubs. 10 guys, 5 to 10 k each. Not saying this is the way to go but it could be a great way to learn longer term trading strategies.

    Take a look at the stock of Mosaic Co. (MOS NYSE). Who wouldn't have liked to have some shares of that in their portfolio? And with the idea of diversifying and spreading your capital over a number of securities, you could have probably been able to ride a stock like MOS since you didn't have a big stake in it or a large percentage of your overall capital. But if you were swing-trading you would never have held this for months and achieved those kinds of gains.

    So I guess what I'm getting at is this; Even if you only have 20k to work with, rather than do some really aggressive type of trading like buying naked options or futures in an effort to make a lot of money in a short amount of time, learn to build up the equity in your account slow but steady. Sure, we would all love to make a killing and do it in as short amount of time as possible. But this isn't realistic and likely the quickest way to blowing out your account.

    Bottom line: Because commissions are incredibly low, take advantage of it. Don't take huge risks. Spread your money around. Because even with a 20k account; If you were starting out back in the beginning of 07 and bought just 100 shares of MOS @ $20 (10% of your capital and a mere one dollar commissions) your account would be up almost 50% today, even if you had only broke even on your other holdings. Not too bad.!

    Not saying it's easy. And it's especially not easy to ride winners and avoid taking profits prematurely. But one thing is for sure, commissions should not let you from considering this kind of longer-term investing, even if you have a small account. Slow and steady my friends. That's how to get rich, IMHO.

    I welcome opposing viewpoints.