Editor's note: No matter which direction the market is moving, you don't want to invest without a plan. And according to our founder Porter Stansberry, the right allocation strategy can make all the difference. As he explains in this classic piece, which we most recently shared in DailyWealth in August 2024, you should keep four principles in mind when building your portfolio – because they could dramatically improve your potential gains.

George Maddox went "all in" on one stock with his retirement savings... and it almost worked out.

George had played by the rules and done just about everything right.

For more than 30 years, he had been a loyal, hardworking employee at what was one of America's largest companies. He scrimped and saved, putting money into his employee stock plan every month. And by the time he retired, he owned more than 14,000 shares – a holding that was eventually worth well over $1 million.

George was set for life... or so he thought.

Unfortunately, George's former employer was Enron.

The now-notorious energy-trading firm went bankrupt after a massive fraud scandal in 2001. Its stock price cratered... and George's nest egg collapsed to just $3,600.

Lou Pai – the head of Enron's Energy Services division in Houston at the time – could have faced the same disaster. But that didn't happen.

What ultimately separated George and Lou – besides dumb luck – was one of the simplest yet most important concepts in investing. And today, we'll cover four ways to put it to work...

You see, Lou had an obsession with visiting high-end strip clubs. It ultimately led to his divorce... But it saved his portfolio in the end.

The divorce forced Lou to diversify his life savings out of Enron's stock – unlike poor George.

Asset allocation is critical. This is how investors invest, or "allocate," their capital across (and within) different asset classes like stocks, bonds, real estate, and commodities.

In fact, research suggests asset allocation can be more important than the individual investments you own. Studies have shown that the specific combination of assets in a portfolio can account for 80% to 94% of its total return.

One popular approach is a 60% allocation to stocks and a 40% allocation to bonds or fixed income (the classic "60/40 portfolio"). Another is the "100 minus your age" rule... which assigns a gradually smaller percentage to stocks (and a larger percentage to bonds) with time.

The idea is to reduce exposure to riskier and more volatile stocks as you move into retirement. However, both approaches leave out other assets – like real estate, commodities, gold, and even bitcoin – which can add more diversification and potentially produce better risk-adjusted returns.

No one-size-fits-all allocation is right for every investor. That said, some general guidelines can help you decide for yourself...

How to Balance Your Portfolio

Porter & Co. analyst Erez Kalir joined me in March 2024 for an in-depth discussion on this topic. Here are some of the highlights...

1. First, you need to balance your "risk barbell"...

Think of an investment portfolio as a barbell. The goal is to offset any high-risk assets on one side with super-safe assets on the other, so that overall risk is balanced. Take a look at this example...

Of course, investors don't need to take a lot of risk to earn market-beating returns over the long run...

But if an investor does decide to invest in riskier assets, he should own super-safe and prudent investments as well. And generally, the more risk an investor takes on one side, the more conservative he should be on the other.

This idea also encourages sensible position sizing, so you don't invest too much capital into any one position.

2. Know your investment horizon and risk tolerance...

I always say that investors should own "forever" stocks... the kinds of companies you can buy and hold forever.

The surest way to build wealth in the market is to simply buy great businesses when they trade at good prices and never sell them – allowing the magic of compounding to multiply your capital tax-free.

However, depending on one's age and circumstances, an individual's investment horizon may be far shorter. For some, that might mean allocating more of their portfolios to fixed-income investments and less to equities.

Similarly, risk tolerance should factor into an investor's allocation decisions...

For example, even Warren Buffett's Berkshire Hathaway – one of the greatest businesses in history and an extraordinarily low-risk stock – has temporarily lost 50% of its value on three separate occasions over the years before rebounding to new highs.

Investors who can't tolerate that type of volatility would be wise to minimize their equity exposure and focus more on fixed income.

3. Maintain a reasonable number of positions...

There's a limit to how many positions anyone can manage effectively. Even full-time or professional investors only have so much time and attention.

Yet many investors end up owning dozens, or even hundreds, of individual positions. This is a recipe for poor returns – if not outright disaster.

Erez and I agree that most investors should limit the total number of individual investments to no more than 18 positions. This is a small enough number to be manageable, while still allowing for good diversification.

4. Embrace change with "dynamic allocation"...

Markets – like the seasons – change. Some assets, sectors, and individual companies come into favor, while others fall out of favor. Some become wildly overvalued, while others are left for dead.

Investors who are willing to occasionally "break the rules" and allocate significant portions of their portfolios to extreme value can earn incredible returns with very little risk.

This approach was a favorite of the late Berkshire Vice Chair and Buffett's sidekick Charlie Munger, who passed away in late 2023.

Investors would routinely ask Munger how to get rich in stocks. And he would consistently point to these kinds of rare opportunities – opportunities that may only come along a handful of times in an investor's lifetime.

The key, Munger noted, was to have the patience to wait for these "fat pitches"... and then to have the courage to "swing hard" when they inevitably arrive.

Investors who use these four principles are likely to dramatically outperform those who blindly follow the generic allocations recommended by many financial advisers... or who don't think about asset allocation at all.

Regards,

Porter Stansberry

Editor's note: Now's not the time to get complacent. Porter says one of the country's most important institutions is about to go broke... catching most Americans completely by surprise. That's why, on Thursday, June 5, he's coming forward to walk you through exactly what he's doing with his own money to prepare for the coming weeks – and how you can prepare your portfolio too.