Step 6: Start Small

This is the sixth in a series of articles elaborating on the 9 Steps To Build and Manage a Dividend Portfolio.

Initiate new positions with a smaller investment

Once an investment has been thoroughly researched and decided upon, it may seem like initiating the investment is trivial. Knowing how much to invest, however, is another significant decision.

This article isn’t about what percentages you should have for individual stocks in your portfolio, or a discussion on what the optimal number of positions is. Rather, this discussion begins after you’ve decided the approximate position size you want in an investment (based on your confidence in the company, the target diversification, and number of positions in your portfolio). Once you know what position size you want, the next question is how to get there.

The “clumsy” way to do it is to take a lot of your available investment capital and immediately enter your full position. Now, this may be appropriate if your positions are small and therefore due to trading costs it makes sense to enter it in one trade. But if you have a larger portfolio, it typically makes sense to build positions over time. The reasons to start small with stock positions are many:

Stock Movements
Large stock swings could give you better opportunities later. Even blue chip companies can have fairly dramatic stock valuation changes over the course of several months, and smallcaps are even more volatile. A long-term dividend investor typically cares little for stock price- save for always being on the lookout for better and better buying opportunities. Entering a position all at once is like putting all of your eggs in one basket; you’re declaring that this is a great value and disclaiming the option to continue to look for better values. In reality, the market is kind enough to give patient investors opportunities to add wisely to their positions.

Familiarization
You may have misjudged your decision, and taking more time to familiarize yourself with the company can help you find faults with your investment analysis, realize things you missed, or perhaps boost your confidence in your initial estimations. Every investor, no matter how experienced and patient, is going to make an investment mistake from time to time. Minimizing the scale of mistakes by starting small and entering positions over time can keep your losses minimal. There’s an element of risk with any investment, and it’s better for a mistake to occur with a small position than with a large position.

Reserves
It’s always a good idea to have sufficient capital available. You never know when you might come across a great investment at a great time. Similarly, you never know when the whole market might retract and give you plenty of attractive buying opportunities across the board.

Efficiency
Breaking an investment up into smaller chunks might sound like it adds a lot of work, but it doesn’t have to be. Once you have a fairly substantial and diversified portfolio, adding to existing positions is a lot easier than initiating new stock positions, as long as you consistently record your investment thesis for each investment. When you’re familiar with a company, and you know the reasons you invested, it only takes a fraction of that information to add to the position. There’s usually no need to start from scratch and analyze the investment all over again (although doing this occasionally isn’t a bad idea either). Instead, you need only take into account any significant changes that occurred since your last investment, including price changes, major business changes, revised outlook, and updated dividend and financial information.

Conclusion

In summary, there are plenty of reasons to build your positions over time. How much you should invest in any one trade depends to a certain extent on your portfolio value, your invest-able income, and your trading costs. It’s best, when possible, to avoid going too far into an investment on a single day, assuming one has a very long-term view of the holding and isn’t looking to cash in on quick stock moves.