Allocate 25%

Hobby stocks are stocks that you want to buy but which you might not be able to justify to other people.

How much should you allocate to hobby stocks?

My answer: 25% of your stock holdings.

Two Analogies

I draw my conclusion from two time-tested analogies.

The first is a slice-and-dice approach. You allocate equally into four low cost index funds. Each index fund represents one of the four major stock categories. They are Large Capitalization Growth stocks, Large Capitalization Value stocks, Small Capitalization Growth stocks and Small Capitalization Value stocks.

You rebalance annually to restore the initial 25% allocations.

The original approach has worked well. My research indicates that you could do a little better by emphasizing those components that have delivered the highest returns historically.

Why not replace the poorest performing component, Small Capitalization Growth stocks, with hobby stocks? You won’t give up very much if your hobby stocks don’t do well. You will gain quite a bit if they do. Allocating 25% makes a difference.

My other analogy is Benjamin Graham’s allocation between stocks and bonds. He recommended that both allocations remain between 25% and 75%. His constraint has stood the test of time. Investigators have concluded that it minimizes regret.

The magic number is 25%. If you are right, you gain handsomely. If you are wrong, the rest of your portfolio will do well enough to overcome your disappointment.

Have fun.

John Walter Russell
April 2, 2006