Course Module 115: Portfolio Allocation Strategies
How to profitably assign investable capital and dividends paid
Summary
Portfolio allocation, or how to assign investable capital and dividends to a basket of common stocks, is as important as asset allocation.
By equal-weighting a portfolio, thoughtful investors treat each component equally regardless of price, market cap, or sentiment, negating the need to speculate which holdings will outperform in the long run.
Patient and disciplined quality-driven value investors allow dividends and capital gains distributions to settle as cash and reinvest those funds when prices are attractive.
It takes just a few big winners for an entire portfolio to beat the market over time.
Course Module 115 concludes with voluntary action items and suggested resources.
Now that we have learned how to research and purchase the value-priced common shares of select quality companies in Course Modules 101-114, this module addresses the critical strategies for managing portfolio allocation.
Common stock portfolio allocation, or how we assign securities, dividend payouts, and investable cash within our concentrated basket, is as important as the asset allocation of stocks, bonds, real estate, and money markets in more diversified portfolios.
Subscribers have queried me for universal suggestions on allocating investment capital when starting or maintaining a portfolio of predominantly dividend-paying common stocks.
How do independent investors initiate new investments or add holdings to a portfolio according to a weighting mechanism? Should they automatically reinvest dividends? Or store the cash as dry powder in an FDIC-insured or similar money market/sweep fund and wait for value prices?
Module 115 explores two standard options for portfolio allocation and why one method makes the most sense for retail-level, quality-driven value investors.
Course Module 115 Syllabus
Subject matter objective: Present proven strategies for managing portfolio allocation and how to assign investable capital and dividends to a basket of high-quality common stocks.
Weighting mechanisms for alpha-achieving capital allocation
How to choose a portfolio allocation option
Performance of the ten original QVI holdings on an equal-weighted basis
How disciplined value investors reinvest dividends paid
The importance of understanding our opportunity cost
Why stock holding allocation is paramount to portfolio performance
Course Module 115 voluntary action items and suggested resources.
Weighting Capital Allocation
The two universal portfolio weighting mechanisms are market-weight and equal-weight.
Introduced in Course Module 105: Behavioral Investing — Common Sense was how the controversial use of market-cap-weighting dominates portfolio weighing mechanisms. Market cap, or capitalization-weighted indexes, assign component value by the total market value of the outstanding shares against the cumulative market cap of the investment basket. Thus, the largest market-cap stock in the portfolio has the most significant influence on overall performance. Market capitalization is the closing share price times the number of common shares outstanding.
By equal-weighting a portfolio, investors treat each component equally regardless of price, market cap, or market sentiment. As presented in the QVI newsletter posts, Alternatives to Passive Indexing 1 and 2, other weighting mechanisms exist, such as free-float market-cap-weighted, price-weighted, and fundamental weighted.
The S&P 500 Index, the benchmark for the QVI Real-Time Portfolios, is free-float market capitalization-weighted. With this method, a factor is assigned to each stock to account for the proportion of outstanding shares owned by the general public, as opposed to shares held by the government or company insiders.
The Dow Jones Industrial Average uses price weighting, where the higher-priced components receive the maximum weight. In contrast, fundamental weighting favors sales, book value, dividends, cash flow, and earnings.
Choosing a Portfolio Allocation Option
Remember that investing using a market-cap-weighted allocation translates to following the crowd, as the higher the market cap, the more popular the stock. I equal weight our family portfolio, as illustrated in the QVI Concentrated Portfolio, for the best approach to measuring overall performance against its benchmark.
To equal weight a portfolio, buy the same amount of dollars per holding or perhaps counterweight using the same number of shares in different dollar amounts. Despite being partial to the stocks purchased, we never know what holdings will outperform the benchmark in the long term. To maintain equal weighting in our portfolios, remember to rebalance at least once yearly by reducing the winners and adding to the underperformers meeting our valuation criteria. Equal-weighting has worked well for the QVI Real-Time Portfolios toward their collective market outperformance over 14 years since inception.
Attempting to bet what specific stocks or ETFs in our portfolios will beat the market over an extended holding period is akin to predicting what teams win the Super Bowl, World Series, or March Madness in 2029. Placing a speculative wager is the best we can muster. Making bets and crossing fingers is the antithesis of thoughtful, disciplined, and patient investors. Equal-weight works best for buying and holding the mispriced, predominantly dividend-paying common shares of high-quality companies with compelling value propositions.
Suppose we purchase bargain-priced stocks of well-managed, shareholder and customer-friendly companies with excellent competitive advantages and palatable downside risks. In that case, the prospect exists that most of the holdings outperform the benchmark over time, such as the legacy holdings of the QVI Portfolios. And the likelihood increases for the winners outnumbering the losers in the portfolio. Also, by equal weighting, there is no need to overweight by speculating what individual holdings will outperform the targeted benchmark.
For example, here are the total return performances — adjusted for stock splits and dividends — of the ten original holdings of the QVI Real-Time Portfolios, each held longer than seven years and as of the market close on November 20, 2023.