Most of us will spend a lot of time researching stocks. The hunt to find a new exciting business to add to your portfolio is invigorating (at least for us investing nerds). 

We seem to lose this enthusiasm when talking about portfolio management and diversification. However, it can be just as or more important than stock analysis. 

Today, let’s explain one of the tried and true portfolio allocation frameworks: the 60/40 portfolio. 

What is a 60/40 Portfolio?

Using the 60/40 portfolio method means you have 60% of your savings in stocks (equities) and 40% of your savings in bonds. Simple. 

Then, on a regular basis — usually every quarter, half year, or year — you will rebalance your portfolio back to the original 60% stocks and 40% bonds allocation. If stocks have done better than bonds and become a larger % of your portfolio than 60%, you will sell your stock holdings down to 60% and use the proceeds to up your bond allocation back to 40%. 

The 60/40 portfolio can work to dampen portfolio volatility (i.e. major price swings) for people that need to draw on their savings for expenses.  Why? Because of the inverse correlation between stock and bond returns. 

Generally, if the stock market is in the gutter, your bonds will do well when the government lowers interest rates. When the stock market has gone into a bull market, bonds will be underperforming due to the limited upside of these assets. 

Using the 60/40 and periodic rebalancing can help dampen major drawdowns in your portfolio. 

Should I utilize the 60/40 strategy for my portfolio? 

As mentioned above, you should consider utilizing the 60/40 portfolio if you need to draw on your savings for spending in your day-to-day life. Having to draw money out of your savings account when it is in a huge drawdown means you risk quickly depleting your savings. 

If you have your portfolio in 100% equities, bear markets can hit your savings quickly. This is okay if you are not drawing on your savings today and have a multi-decade time horizon, but can be devastating if you need to withdraw that money. The 40% portion of the 60/40 portfolio in bonds and the automated rebalancing rules alleviates this bear market risk.

Think that this won’t happen to you? Take a look at inflation-adjusted data for the Dow Jones Industrial Average in the middle of the 20th century. From the peak in the mid 1960’s, investors saw deteriorating wealth through 1982, when a new bull market began. 

Overall, investors should understand that the 60/40 portfolio allocation is a tool they can use if it is appropriate for their personal circumstances.

Matching Up Your Portfolio With Your Personal Financial Situation

You may be searching for one answer when it comes to your portfolio. A set of rules that apply to all investors, which you can follow in a step-by-step path to success. Simple, right?

Personal finance does not work this way. 

As a beginning investor, you need to take heart the personal in personal finance. While our resources, stock pitches, and community feed can help you become a better investor, nobody knows your financial situation better than you. 

Manage your investment portfolio with this in mind. The correct answer to portfolio management is not going to be the same for everyone. It all comes down to your personal financial situation.

Let’s look at two extreme ends of the spectrum to illustrate. 

First, we have a young professional who just graduated college, does not carry any student loan or personal debt, and is starting a job in an expensive new city. 

This person does not have any savings but wants to start stowing some capital away for a rainy day. They will be able to save around $1,000 every month. 

With decades of personal earnings power ahead, this young graduate can be more aggresive with their stock portfolio. Their portfolio is smaller, will have a ton of future deposits coming through, and they will not need to draw on this money for a long time.

The young graduate will likely want to put their entire portfolio in stocks. They don’t need to immediately diversify, and could even start out with just a few stocks in their portfolio. Over the next few years — as long as they consistently deposit money in their savings fund — they can diversify their savings with new stocks and/or other financial assets. It is okay for them to be patient. 

The opposite end of the spectrum is a retiree who is not working anymore. They may have some cash coming in from a pension or social security, but this is mainly a fixed savings account that they will need to draw on every month.

In this scenario, diversification matters more. Short-term price movements and volatility matter more. Wealth preservation and fixed income matter more. A portfolio of low-risk stocks and bonds will make more sense here. Part of the portfolio can invest with the same philosophy of the young graduate, but only a small portion. The retiree has an entirely different financial situation and likely financial goals.

Investing is just a means to an end, a way to enable our life goals and give us financial freedom. Remember this when forming your portfolio management strategy. Don’t go chasing what is hot if it doesn’t match what you set out to do. 

Portfolio management is personal, just like the rest of finance. Think about your financial situation and make sure to match up your portfolio management with your own goals and life circumstances. 

One Tactic for Beginners: Starter Positions

After learning about the basics of portfolio management, we can get down to some tactics beginners can implement in order to build a thoughtful portfolio. 

One common tactic investors use is the starter position. Implementing a starter position means buying a new stock for your portfolio, but making it at a tiny size. This could literally mean buying one share or a fraction of a share (if your brokerage offers that option).

(Side note: most brokerages offer fractional shares. Here is a list from Nerd Wallet)

Benefits to using starter positions

There are a few benefits to using starter positions in your portfolio.

First, it allows you to enter a position in a company you may not know very well at the moment but still think is a potentially promising company. If you get more conviction in the company’s future prospects, you can add more to your position over time.

Importantly, if the stock doesn’t work, it won’t overly hurt your portfolio. If you have 20 starter positions that make up 0.5% of your portfolio, that will only end up being 10% of your portfolio allocation. If a few of these starter positions end up being mistakes, you will barely notice the difference compared to a full position that may range from 5% – 10% at cost (or maybe lower depending on your risk tolerance). 

Second, starter positions allow you to take positions in riskier businesses that have high upside and downside skews. Like above, if these risky businesses go to zero, you won’t see a huge impact on your portfolio. If they do well, it will turn into a full position over time.

For example, I was interested in Rocket Lab stock early in 2024, but thought it was a high risk company. I did not invest in the stock, and it is unfortunately up around 500% in the last twelve months as the thesis plays out. Perhaps I would have been better served to make the stock a starter position. 

Third, you can treat your starter positions like an active stock watchlist. With thousands of stocks out there, we can’t put our full attention on every company in the world. Starter positions are a forcing function — due to the fact you now have money invested and skin in the game — to make you follow a business more closely. 

Downsides to starter positions

From my perspective, there are two main downsides to starter positions. 

First, you can get overwhelmed with too much “clutter” in the portfolio. Trying to track 40 – 50 stocks may get stressful and drag your focus away from the core positions that you own. If this is something that negatively impacts you, maybe starter positions are not a good tactic for you and you need to build robust watchlists instead. Or, perhaps you can lower the amount of starter positions in the portfolio.

Second, too many starter positions can lead to what is called “diworsification.” This means that you are overly diversified and essentially have built a portfolio that is no different than an index fund. While position sizing can impact this, it is a common mistake I see many investors make. After 30 or so positions you likely have plenty of diversification. 

Starter positions are a great tool for investors to build out their personal portfolios, but make sure to not overuse it. Use this tactic with new stock ideas and riskier businesses that have high upside potential.