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Ever hear of the 80/20 Rule (aka the Pareto Principle)?
It’s the rule that states that 80% of your results come from 20% of your efforts.
It applies in all sorts of situations (and is totally backed up by the numbers)…
If you study traffic patterns you’ll see that 20% of the roads carry 80% of the traffic.
If you look at wealth, you’ll find that 20% of the countries (or individuals, depending on how you’re measuring things) hold 80% of the wealth.
It even applies to drinking beer. I kid you not. Research has found that about 10% of the population in the US consumes around 75% of the alcohol.
So as you can see from the last example, it doesn’t have to be exactly 80/20. It can be 90/10 or even 99/1. Or whatever.
The key takeaway is that a relatively small percentage of roads, people, countries, beer drinkers account for WAY more of the traffic, wealth or drinking.
The same goes for investing.
Specifically, let’s say you invest in 20 stocks. Chances are 1 or 2 of those stocks are going to result in the VAST majority of the increase in your portfolio’s value.
Now, you could be thinking that the opposite is true. That 1-2 of them could be total stinkers and drag the rest of your portfolio down. And, you’d be right but…
… one of the most important rules of investing is to sell your losers quickly. In fact, you should never let a stock in your portfolio drop more than 10% at the MOST. I usually sell my losing stocks much quicker than that.
Let’s take a look at some numbers to see how this can work to pad your pocketbook over time.
Say you bought 20 stocks 5 years ago. You put $1000 into each stock. $20,000 total. With me so far?
And, worst case scenario, 19 of them were horrible picks and you sold each for a 10% loss. You’d be out $1900 (19 X $100 loss on each).
But the 1 stock you didn’t sell was Tesla. Looking at the numbers at the time I’m writing this, your $1000 of Tesla stock would now be worth over $7000.
So, overall, your portfolio would still be up 20% in that time all thanks to 1 big winner that made up for all the other stocks that sucked donkey, ummm, tails.
If you can build a portfolio of leading companies and sit tight for 3-5 years, chances are you’re going to have a few that blast off in that time. And those will more than make up for the bad investments.
It’s the 80/20 of investing.
By having patience, picking just a handful of great stocks and cutting your losses, the numbers will usually work out in your favor.