No matter what kind of investor you are, it's that your portfolio is well-diversified and that you monitor and rebalance your it regularly to ensure that the diversification is maintained. So if at any time one stock grows to more than 15% of your portfolio's value, take the time to figure out how much risk you are taking on that particular stock.
Even if you're convinced that the company has good prospects, it's not prudent to allow any one stock take up a large percentage of your portfolio. If your portfolio is heavily concentrated on one or two stocks, sell part of those particular holdings to ensure diversification. If you have one or two big winners, and their future still looks bright, consider taking some profits off the table and adding to your other holdings, just so you won't be overexposed in case the unexpected happens.
For example, suppose you started with a portfolio, of which 12% was shares of ABC Ltd. If ABC's stock price increased in value through the last year, but there was not much change in the value of other stocks in your portfolio, you may find that ABC has grown to more than 22% of your portfolio's value. If the ABC's stock price were to fall due to some unforeseen circumstance, the performance of your entire portfolio would suffer badly. So even if you are convinced that ABC is a good investment, and that its future looks bright, it would still be a good idea to sell some of your ABC shares.
At the same time, you could consider increasing your holdings in XYZ Ltd, another company in your portfolio with good fundamentals and perhaps an undervalued stock. Or you could buy new stocks. You should also consider whether your stock portfolio is heavily concentrated on a particular sector. If so, reduce your exposure to that sector by offloading a few stocks in it, to increase diversification. If you are a prudent investor aiming for diversification, it's advisable to revisit your portfolio every quarter, to see if your holdings are still in balance.
And now we come to the third and last rule for selling: "Sell a holding if the stock is overpriced, or if the market as a whole is." When a stock is overpriced, it means a better alternative is available, and you already know Rule Number One above. But what if the whole market is overpriced-in such a case, stock prices do not support valuations. In such a scenario, finding a better alternative may be a very difficult task.
We saw such a situation in January 2008, when the Sensex was above 21,000-and a single sharp drop of 7.4%, followed by aftershocks, caused many investors lose money. In such a scenario, it's wise to book profits, review your asset allocation, and rebalance your overall portfolio. It's important to keep in mind that successful investing entails diversification not only within a particular asset class, but also across asset classes.
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