Most investors make regular investments into their portfolios as they work towards retirement.
But what’s the best way to do that? Should new money be used to buy more holdings or to top up existing holdings?
And if it’s going to be used to top up existing holdings, which ones should get the additional investments?
This is a topic I get asked about on a regular basis, so in this article, I’ll explain the rules I follow when making regular investments in my own portfolio, with an emphasis on keeping diversification up and risk down.
Add small regular investments into new holdings
Much like a garden, a portfolio of shares needs regular maintenance. One of my maintenance tasks is to take profits on the best-performing shares, weed out underperforming companies and then reinvest the proceeds of both into new holdings.
I do this on a monthly basis, alternating between selling something one month and reinvesting the proceeds of that sale into something new the following month. As a result, I add a new company to my portfolio every other month, regardless of whether or not I’ve injected any new cash.
Because I’m regularly buying new companies anyway, it’s quite easy to just mix small regular investments into that existing process.
Picture this imaginary scenario:
- I have a £100,000 portfolio with 30 holdings that are approximately equally weighted (around £2,000 to £4,000 per holding)
- I have a regular investment plan to save an additional £1,000 into the portfolio every month (1% of the portfolio’s current value)
With 30 holdings I would have a default position size for new holdings of 1/30th of the total value, i.e. 3.3% or £3,300 in this example.
In reality, though, the starting size will vary between perhaps 3% and 4% (£3,000 to £4,000 in this example) depending on the amount of cash in the portfolio following the most recent sale, plus any dividends received.
With £1,000 of new cash entering the portfolio every month, that’s an additional £2,000 (2% of the portfolio’s value) of cash being added between each new bi-monthly stock purchase.
If the portfolio already had a cash holding of say £3,000 (3%) left over from the previous sale plus a few recent dividends, then by the time of the next purchase there would be at least £5,000 (5%) of cash ready to invest.
5% is quite a lot for a single holding and generally I would prefer to start new holdings off closer to the default size of 3.3%. However, I think starting a new holding off at 5% is just about acceptable from a risk and diversification point of view.
So in this example, I would invest the whole £5,000 (5%) and leave the portfolio with no cash at all, but that would soon change when I added my next regular investment and when the next batch of dividends rolled in.
During “sell months” (i.e. months when I’m selling an existing holding rather than buying a new one) I would just leave the cash in the broker account to be invested during the next “buy month”.
Personally, I like this approach of adding new money to new holdings because it doesn’t involve making any additional trades. It helps to keep trading fees low, which is something I’m always keen to do.
So here’s my first rule of thumb.
Regular investment rule of thumb:
Invest small regular investments (up to 1% of the portfolio’s value per month) into the regular bi-monthly new holding, keeping its position size below 5%
If you don’t yet follow this regular buying and selling pattern then you may want to invest small amounts using the approach below.
Add medium regular investments into new holdings and the best existing holdings
I think it would be difficult to add much more than 1% per month to these every-other-month purchases (i.e. an additional 2% per new holding) and still keep the new position sizes below 5%.
That’s because, in a 30-stock portfolio, the previous sale is likely to have generated a cash amount of at least 3%. 3% plus the 2% of new money leaves 5% to invest, and that’s without taking dividends into account.
At some point, the portfolio would start to fill up with excess cash and it would be better to invest that cash rather than having it earn little or no interest in the broker’s cash account.
One option is to invest the cash into more new holdings, taking the total up from 30 to 40, 50 and beyond. I think this is a reasonable option for some investors, but I would rather not have the additional headache of keeping up to date with 50 or more companies.
So my preferred approach to dealing with regular investments of more than 1% of the portfolio’s value is to invest the first 1% into new holdings as before, and then invest the rest into existing holdings.
However, not all existing holdings are equally attractive and I would prefer to invest this new cash into only the best existing holdings.
Here are a couple of questions I would ask before topping up an existing holding:
- Is the stock ranked highly on my stock screen? I would rather invest in higher-ranked holdings over lower-ranked ones and I wouldn’t invest additional funds into one of the five lowest-ranked holdings.
- Does the stock still pass all of my investment strategy’s buy criteria? If it doesn’t then choose something else.
These two questions will direct new cash into the most attractive holdings, but there may still be practical reasons why I wouldn’t top up a particular stock.
The most important reason is the risk of over-investing in a single stock, either in terms of the total invested to date or its current position size.
To avoid that, I have a couple of further questions:
- Can I invest more than £1,000 into this company without the total book cost (the total amount invested so far) exceeding twice the default position size (e.g. 2/30th or 6.6% in a portfolio of 30 stocks)?
- Can I invest more than £1,000 into this company without taking its current position size above 5%?
Note: The reason for the £1,000 minimum investment is that I want to keep trading costs (typically around £10 per trade) to less than 1% of the amount bought or sold.
If I can’t answer yes to both of those questions then I wouldn’t top up that particular stock at the moment, although I might do so in future if the situation changes.
Given those restrictions, how many investments will typically fall into this “best” category?
Looking at my own portfolio (which closely mimics the UKVI portfolio) there are 30 holdings and currently, 16 of them make it into this “best holdings” category, and those are the stocks into which I would funnel additional cash.
If you’re wondering why the other 14 holdings are no longer in the “best holdings” category, have a look at this recent article on whether to sell or hold onto underperforming companies.
Here’s another imaginary scenario:
- I have a £100,000 portfolio with 30 approximately equally weighted holdings
- I have a regular investment plan to add £3,000 per month to the portfolio (3% of the portfolio’s current value)
The first thing I would do is allocate about 1% per month to the new bi-monthly holding, as before. So in this scenario, I would add about £2,000 (2%) every other month to the latest new purchase, whilst keeping its position size below 5%.
That would leave £2,000 (2%) of new cash still to invest each month, in addition to cash from dividends.
Unlike the regular bi-monthly new holding purchases which only take place in the first week of alternate months, I would be willing to invest additional funds into existing holdings as soon as the cash was available.
In the above scenario, I would run through the four questions and pick an existing holding to invest at least £1,000 in (to keep trading costs down).
With 2% or thereabouts to invest each month, I think that should be possible given the choice of 16 “best” holdings. Sometimes it might all go into one holding, while at other times I might spread it across several, but I don’t think deploying 2% a month into the best holdings would be especially difficult.
If for some reason there wasn’t a suitable “best holding” then I would just leave the cash where it is and run through the questions again the following month.
Eventually, it’s inevitable that the cash could be deployed somewhere, in a timely fashion, into the best holdings, with relatively low trading costs, and without over-investing in those best holdings.
However, I think it might be difficult to invest new cash totalling more than 3% of a portfolio’s value each month using this approach.
With much more than 2% per month being added to a select few existing holdings, I think each “best holding” would eventually be pushed up to 5% or more of the portfolio’s value, at which point I wouldn’t want to invest in them any more because it would over-expose the portfolio to those companies.
I’ll cover making large regular investments of more than 3% per month in the next section, but first, here’s another rule of thumb.
Regular investment rule of thumb:
For medium regular investments (between 1% and 3% of the portfolio’s value per month) invest the first 1% into new holdings as before. If possible, invest the remainder into the most attractive existing holdings, as long as their position sizes remain below 5% and their book costs remain below twice the default position size (e.g. 6.6% for a 30-stock portfolio).
Add large regular investments to as many holdings as necessary
If I was making regular investments of more than 3% or so of my portfolio’s value, I would initially follow the same process as above.
I would invest cash into new holdings and the best existing holdings first, but when their capacity to absorb additional cash ran out I would be willing to top up less attractive holdings.
More specifically, I would invest any leftover new cash into existing holdings that no longer passed all of my buy criteria.
This willingness to invest additional funds into companies that no longer meet all of my buy criteria might seem like a double standard, but I don’t think it is.
The future is a very uncertain place and just because a holding now fails some of my pre-purchase criteria (perhaps after I bought it the company loaded up with more debt than I’d like), it doesn’t automatically follow that it will be a bad investment.
So I’m quite comfortable with the idea of investing in existing holdings that no longer meet all of my buy criteria, but I would:
- Start by looking at those with the highest rank on my stock screen first
- Favour those that fail my criteria by a smaller margin over those that fail by a larger margin
- Avoid topping up holdings where the company or its valuation seem too risky
- Avoid the five lowest-ranked holdings because those are the ones I’m likely to sell in the next few months
There is some subjectivity in this process, but that’s fine; our gut feelings and instincts can be just as valuable as our rational analyses.
Here’s one last scenario:
- I have a £100,000 portfolio with 30 approximately equally weighted holdings
- I have a regular investment plan to add £5,000 per month to the portfolio (5% of its current value)
The first £1,000 (1%) can be rolled up and invested into the regular bi-monthly new holdings, and another £2,000 (2%) can be invested into the best existing holdings, i.e. high ranking holdings which pass all of my buy criteria.
That leaves another £2,000 (2%) building up in the cash account. At this stage, I would look at my list of holdings, ordered by their attractiveness (i.e. their rank on my stock screen).
Let’s say the highest ranked holding which fails my buy criteria has a debt ratio of six, which is more than my preferred maximum of five. The next highest-ranked stock which fails those criteria might have a debt ratio of 5.1, which is only very slightly too high.
In that case, I might decide that the company with lower levels of debt was the “next best” holding, even though it has a weaker stock screen rank than the higher debt company (and ignoring all the other details that could go into a decision like this).
After topping up that “next best” holding as much as possible I would move on and invest in gradually less attractive stocks until all of the newly added cash was invested.
If at some point there really was nowhere acceptable to add the additional cash, I would simply leave it as cash and wait for one month before starting the whole process again.
As before, I think it’s inevitable that the cash could be deployed somewhere, even if the amounts being regularly invested were very large relative to the current portfolio.
Here’s the final rule of thumb.
Regular investment rule of thumb:
For large regular investments (more than 3% of the portfolio’s value per month) invest in new holdings first, followed by the best existing holdings, as before. Invest any remaining funds into holdings that no longer meet all of the buy criteria. Start with holdings that have the best combination of stock screen rank and margin of failure, and then work down from there as necessary (keeping book costs and position sizes to acceptable levels as previously defined).
Some final thoughts and lump sums
In the real world, this process is quite simple.
In practice I just:
- Invest new money into new holdings first, followed by
- topping up the best holdings, and then
- topping up gradually less attractive holdings,
- all whilst keeping book costs and position sizes under control, and
- only making trades with a value of £1,000 or more to keep costs down
As for lump sum investments, I would apply the same rules and base the book cost and position size considerations on the size of the portfolio including the lump sum.
But I wouldn’t necessarily rush to get the lump sum invested as fast as possible.
Investing is a long-term activity and so I wouldn’t be overly concerned if it took me many months, or even a year, to fully invest a large lump sum.
Of course, this isn’t the only way to do it, or even necessarily the best, so if you’re aware of any other schemes for handling regular investments then please share them in the comments below.
Hi, John,
I was with you for large parts of your regular investment plans but would point out two drawbacks which I avoid in my own planning:
(1) Regular investing (bi-monthly, in your principal example) is all very well and will eventually perhaps smooth out the ups and downs of the market, but personally I shy at putting in new money when the market indices are within a percentage point or two of their 52-week high and, conversely, will look to invest when near their low. I know we can only time the market with hindsight but I have found this general rule works well, and with it I have beaten my chosen benchmark index (the FTAS) in all but 9 months in the last four years that I have kept to this plan.
(2) Unlike you (and, in fairness, most other investment commentators) I have no qualms in allowing my best stocks to occupy a greater than 5% share of my portfolio. Again I have found that there is absolutely no harm in allowing a stock to run and run, and cannot see any point in selling because of a danger of imbalance in the case of a stock which I would still add to and meets all my ‘buy’ criteria. I hold two or three stocks that are over five times my average holding size but am not prepared to sell them until they become under-performers for at least four consecutive quarters (my principal ‘sell’ criterion). I would add that these stocks are all in the FTSE350 and therefore unlikely to become worthless overnight!
(3) Spreading your top-ups over several holdings in order to attempt to keep these at or need average level seems to me to be counter-productive and expensive in dealing costs. Surely it is far better to simply stick to your buying criteria and add to the most attractive stocks at the time, regardless of weighting?
As we all know only too well, buying and selling stocks is a very imprecise discipline and, as you have mentioned, gut-feeling comes into it a lot. Honing our instincts by (sometimes bitter) experience is invaluable and I would venture to suggest that your suggested regular investment planning system is really only perhaps for those who have little interest in monitoring and assessing the performance of their portfolios. I’m sure your readership can do better than that!
Hi Chris, thanks for sharing a little bit about your approach. I don’t want to get into debating the ins and outs of every detail, I’m just happy to have a mix of ideas on the page for people to stumble across and read in years to come.
However (!) I’ll can’t resist making a few quick comments:
1) MARKET TIMING: Your approach is contrarian so that’s fine by me. I don’t do market timing anymore, but I think it can work if you have the right system (i.e. a contrarian one).
2) CONCENTRATION: My limit on position sizes is 6.6%, or actually closer to 6% in practice. That’s just my personal “sleep at night” threshold. If yours is higher then that’s fair enough, but I still assume you have an implicit limit? Would you be happy to have 90% of your portfolio in one stock?
3) SPREADING INVESTMENTS: I only spread new cash across multiple holdings when I can’t fit it all into my top-rated stock, i.e. within my book cost and position size constraints. If I have a lump sum equal to 10% of my portfolio’s value I’m not going to stick it all into my top stock just to keep trading costs down, as that would over-concentrate me in that one holding. I could be wrong about the company and it could go bust (or do a Tesco) and that would make me very sad.
Thanks for your response, John.
To elaborate just a little:
(1) Yes, my investment approach is contrarian and, it seems to me, logical. I don’t buy goods when at high prices if I can avoid it and would not attempt to sell anything at a time when people are not interested in buying!
(2) My highest-valued holding is just over 10% of portfolio value and, with around 55 stocks, I have never had a higher weighting and cannot see the situation arising where I would need to have an implicit limit. I do agree, however, that with a much smaller portfolio this could easily happen and, no, I would not be happy!
(3) Agreed, and I wouldn’t do this myself. I think there needs to be a happy medium here and, again, this would be easier to achieve with a larger portfolio and is another example of the merits of holding a large number of stocks. I do agree with your earlier point, however, that this does mean a lot of keeping track to ensure the balls remain in the air (and I have reached the stage where I only buy a new holding after disposing of another).
Too complicated for me. Probably you suffer from a higher transactional cost. I invest in the same stocks as my clients, so we share the trading cost. We agreegate the orders and up to 100 people we share a £15 trading charge.
It could take several trades to get the order filled and get all the shares we need, and everyone including me gets the average price. We pay however a 0.15% annual custody fee. We can buy most of the stocks available in the world and share the cost, including global delivery from a third party custodians.
Hi Eugen, I agree it looks a bit complicated when written down, but in practice it can be summarised as a handful of bullet points which are easy to remember. I just added in the details in order to explain the underlying thinking.
As for higher costs, I would say I have the same costs as any investor who invests directly in shares. Broker fees are typically about £10 per trade, which is why I usually say investors should probably keep the value of each trade above £1,000 in order to keep the fees below 1% per trade.
Obviously it’s cheaper to trade through a collective vehicle such as a fund or through a financial adviser (which I assume you are), but then of course the clients of financial advisers also have an additional “trading cost” which is the fee they pay to their financial advisor.
Also, one of the reasons I moved to investing in large caps was the ability to invest a few thousand into a company in one lump, because of their greater liquidity, rather than having to invest in drips as was the case when I invested in small caps.
It’s a minor point but it all adds up, and as I’m sure you’re aware it’s important to minimise costs where possible.
John
This all made perfect sense to me. I’d say it fits in with the “defensive” part of the strategy. I’m wondering if this aspect has become a little lost here.
Additionally I’m sure you’re flattered that financial advisors follow you together with their client bases . But, purely rhetorically, I’m left wondering how much better off investors would be following you directly, as I and doubtless many others do?
We all stand on the shoulders of giants, and we stand on yours, and you acknowledge Ben Graham. So I trust those who stand tall with your help, like I do, will publicly acknowledge the roots of their success, allowing others to follow should they wish.
Hi James, thank you for your support, and I’m glad the article made sense.
Would you mind elaborating on your comment that the defensive aspect has become a little lost?
To me “defensive” means low risk, and that’s certainly still front and centre in my mind when I’m developing and applying the “defensive value” strategy.
Feel free to email me if you want a more in depth and/or less public conversation.
Hi James (again), please ignore my previous comment about the defensive aspect being lost.
I’ve read your comment again and now I realise (or think) you meant it had been lost in the article, in other words perhaps I hadn’t emphasised enough that the reason for the various rules on topping up was to reduce risk, i.e. to be defensive.
If that is what you mean then thanks for highlighting it, and I’ve made a small change in the opening paragraph to make my risk-reduction intentions more obvious.
John
You aim to invest defensively, focussing on value. I simply wondered if one of the comments made might have gone slightly wide of the defensive point, maybe not missed altogether. The tactics you describe in this article fit with the defensive mind-set.
I should have made myself clearer. Sorry.
But it certainly will have done no harm for you to have beefed up the defensive (reduce risk) element in the article for future readers.
Okay James, thanks for the clarification.
John, very elaborate system you have and it seems to work well for you.
Couple of points I don’t understand :-
You mentioned that you like to invest new money into a new stock rather than adding to existing investments in a buy month as this reduces trading fees.
In both cases stamp duty will apply so no saving there. Splitting the small value of £3k to £5k into multiple holdings incurs multiple dealing charges – surely a single investment is most optimum to keep trading costs low?
Don’t really understand why you have to sell a stock every other month ? Isn’t this inflating your dealing costs a lot through the year?
Wasn’t it Warren Buffet who wrote “my investment style borders on sloath”?
If you come to a conclusion that a stock must be sold, isn’t it better to do it immediately and not wait up to 60 days? Is it that you want to be less trigger happy and stop yourself selling because of uncertainty of the reason why you want to sell?
I might be missing a trick here, but I have only sold a couple of stocks in 3 years.
LR
Hi LR, unfortunately I think it comes across as more elaborate than it actually is! In reality it’s pretty simple once you’ve used it a few times and even I can remember all of the steps without having to look them up (I have a terrible memory). Onto your excellent questions:
REDUCING TRADING FEES: Yes, my preference would be to make a single investment. If I had say £5k of new cash to add to the portfolio then I would prefer to add that all to one new holding. But if my total portfolio was only worth £30k then that would be almost 17% in one stock, which is too much. So it’s a trade off between reducing costs and increasing risk from over-concentration in certain holdings. As long as the broker fees are less than 1% of the trade then I’m reasonably happy, although less is better of course.
SELLING ONCE EVERY OTHER MONTH: I’m not a buy and hold investor so Buffett’s “hold forever” mantra doesn’t apply. I prefer to turn the portfolio over at a slow and steady pace of one holding every two months, which equates to 20% of the portfolio being replaced each year (six holdings are sold and replaced each year, which is 20% of the total of 30 holdings). That gives an average holding period of five years, which is still fairly long. The aim is to consistently nudge the portfolio towards better companies at lower prices, because over time some of the holdings become not-cheap (e.g. if their share price goes up a lot) while other companies become not-good (e.g. if their dividends are suspended), and those are the ones I want to replace.
WAITING VS SELLING IMMEDIATELY: I don’t like the idea of having to make fast decisions or actions in investing, either when buying or selling. If it’s obvious that I’m going to sell a company fairly soon then I’m quite happy to wait a few months to do it. I think that in the long run any gains or losses from waiting will cancel each other out, and I’m left with the positive side effect of having less stress and more enjoyment from the process of investing.
Everyone has their own way of doing things, and I know some investors who never sell anything unless forced to by a takeover or whatever. If that’s how they want to invest then great; but I prefer to slowly nudge the portfolio towards being the best that it can be.
Perhaps a better analogy is that it’s like playing a very slow game of chess against Mr Market. I move (buy or sell) one of my pieces each month, and over the last five years I’ve made 60 moves, but the game is only just getting started.
All pretty well justified. My problem is it takes me an age to find anything worth buying and when I do it’s even harder to find a replacement.
Still on the bright side it’s better to buy nothing than any old rubbish, quoting Mr Smith.
Onward and upward.
Hi John,
Thanks for this forum. I am just starting out on this path and would love to hear from you some recommendations as to the brokers out there. I am looking for a cheap on-line broker to start with. Which ones have you used and which ones did you like out of those? I know that brokerage fees can eat into your gains and so I am looking for a UK broker that is sensibly priced.
Thanks,
Andrei
Hi Andrei
These aren’t recommendations, but I would say that any of the major brokers should be reasonably cost competitive, e.g. Hargreaves Lansdown, A J Bell (You Invest), or Interactive Investor.
However, there are a million and one caveats, and which is “best” depends on the features you’re looking for. I’ve written about this a couple of times, either directly or indirectly:
Who is the best UK stockbroker
22 tools and guides for active investors
Have a look through that lot and you’ll have a good chance of finding a suitable broker.