Ask Doug: How Should Our Club Reduce an Oversized Holding?


Congratulations! One of your club's stocks is a big winner! Uh-oh -- now it's overweighted in the portfolio!

Jay writes:

Our 24-year old club owns 10 different stocks, one of which is Apple which has performed well over a period of years. However, it now makes up 17.8% of the value of the portfolio. We would like to trim back the holding to the 8-9%range. What would be the best way to approach this? Do we try to pick a target price which if reached it triggers the sale of shares? Do we wait until we have another stock we think will perform better? Or do we simply trim it back and free up cash for a future purchase?

Our club has 7 members, so some of us follow two holdings and some follow one holding.  For a club our size, what would be a good range of stock holdings so they can be properly followed?


Dear Jay,

Research indicates that a portfolio of 15-20 stocks is the “sweet spot” for portfolio diversification in terms of reducing portfolio risk and maximizing return. Million-dollar and up portfolios could increase that to closer to 30 stocks which could help with individual buy/sell decisions.

It’s possible to sustain a portfolio below 15 stocks, but it requires a bit more careful stock selection and vigilance to manage the portfolio risk. In an investment club, members can each cover two or three stocks without too much difficulty. (The StockWatcher Reports on can be a big help here.)

My rule of thumb is that no holding in a portfolio should be less than 3% of the total, which helps maintain focus and portfolio concentration. If a very small holding in a portfolio performs well, it has negligible impact on the portfolio’s total return, but this company requires the same portfolio management attention as larger holdings, so the trade-off isn’t worth it. These holdings should either be closed out or added to.

The maximum size of any holding should generally be somewhere in the neighborhood of 20% - 25%. Often these are the best performers in a portfolio, and my general approach is to let winners ride, so this can weigh in favor of continuing to hold onto these larger holdings. Over time, as new cash is added to the portfolio, purchases can be made to offset the influence of the overweighted stock (if the overweighted stock is in the Defensive Super Sector, consider adding stocks in the Cyclical or Sensitive Super Sectors, for instance).

The biggest reason to watch for overweighted holdings is that they present more risk if the price of the stock falls due to company problems or market volatility. If you have determined that the overweighted holding is at or very close to a price that you consider to be overvalued, then you might consider using a Trailing Stop Loss Order (TSLO) with a stop set somewhere between 5% and 10%. If the stock continues to rise in price, the stock will continue to trail along at your set percentage (in other words, the stop price will go up with the stock price); if the stock suddenly starts to fall in price and hits the stop price, a sell order will be placed.

You can of course set up a TSLO with a particular number of shares, so you don’t have to sell your entire position. The advantage of a TSLO is that the stop rises as long as the stock’s price goes up, but doesn’t decline when the stock’s price goes down, so you can continue to capture gains during periods of overheated market or security valuation.

In an investment club, overweighted and overvalued stocks are prime candidates for use in transfer to a fully-withdrawing member, since it allows for remaining members to defer the capital gains taxes according to IRS rules.

If you are committed to removing the stock, then I suggest focusing on “replacing” the stock instead of selling it. When you find other candidates for your portfolio, compare and contrast them to your overweight holding. If you find a stock that has better quality and likely higher total return potential, then it may make plenty of sense to sell a portion of your overweight holding and purchase shares in the new company. For most investors, this makes the decision-making process easier instead of selling and then sitting on cash.

Generally, it’s better not to defer selling out of concern about incurring capital gains liability. If the prospect of generating capital gains is inhibiting the sell decision, then consider selling an underperforming stock (one that is being held at a loss) in conjunction with a sale of a portion of the overweight stock, thereby equalizing the gains and losses. This can solve two problem at once, removing a problem stock while at the same time reducing exposure to an outsized portfolio position.


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