One way to manage a core-and-explore approach and keep reasonable checks on your behaviour is to limit the “explore” part of your portfolio to no more than 5% to 10%. The amount is up to you, but the point is to decide ahead of time what your explore threshold will be and what rules you’re going to follow—and then stick to those guidelines over time.
Staying disciplined with this portion of your investment portfolio is important because speculative investments such as individual stocks, thematic ETFs and cryptocurrencies can be incredibly volatile. That means your 10% “play money” allocation could quickly become 20% of your portfolio (or more) if one of your speculative picks pans out. Conversely (and perhaps more likely), one of them might turn out to be a dud and lose 50% or more in value.
Just as you would rebalance your core portfolio of diversified ETFs to maintain your original asset mix between foreign and domestic stocks and bonds, you should also rebalance your explore investments when they exceed the threshold you set.
Why take profits?
It sounds counterintuitive to sell a profitable investment and harvest some of the gains, but that’s exactly what you should consider doing if you want your portfolio to remain in balance and maintain a sensible risk profile.
Let’s say five years ago you bought 500 shares of Tesla stock (NASDAQ: TSLA) at a price of $39.33 per share (all figures in U.S. dollars). Your holdings would have been worth just under $20,000. Fast-forward to today, when Tesla shares trade at $996.27 (as of Jan. 21, 2022). Your shares are now worth a whopping $498,135, assuming you’ve held the stock for the entire five-year period.
It’s safe to say your shares in Tesla now represent a far greater percentage of your overall investment portfolio than they did five years ago.
Why sell a stock that’s on such a profitable trajectory? Because its future returns are unknowable. Tesla could continue to lead the electric vehicle and clean energy revolution, or it could fizzle out as other companies emerge on the scene.
Individual stocks can also be highly volatile compared to the broad market. Take the period between February and March 2020. Tesla shares were down 52.55% during that time. Between January and May 2021, the company’s stock price was down 34%.